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January 2008
Tools for Thought
Surprise
As I write this the most likely vice-presidential nominees in 2008 are Democratic Senator Evan Bayh of Indiana and (surprise) current Republican presidential candidate Mike Huckabee. Where did I get this inside scoop? The Washington Post? NBCs Meet the Press? Some great new political blog? Nope, from Intrade, where a contract predicting Evan Bayh is trading at 15.2 (read 15.2%), highest of any of the tradable choices (except "other Democrat" at 18.6). Huckabee's veep "stock" trades at 20 and the "other Republican choice" contract trades at 33.5, pointing to greater uncertainty on the Republican side. OK, so maybe Bayh and Huckabee aren't shoe-ins for the #2 slot just yet, but as we get closer to the conventions this is the first place I'd check.
Intrade is a prediction market (sometimes known as an event market or an information market). You'll likely be hearing a lot more about prediction markets this election year and even perhaps about "the rest of the story," the rapidly growing acceptance of prediction markets to aid in business decision making in corporate America.
Why a Prediction Market?
What are prediction markets and who would use one in a business setting? A prediction market is a new, low-cost and accurate way to collect information about events important to an initiative or a company's future. The most important feature of these markets is their ability to consistently outperform the predictions of one or more forecasters and, research shows, even outperform large, well-known polling organizations. Prediction markets take the place of calling a meeting (and then rescheduling the meeting) and trying to get a usable sales or technology forecast consensus from your experts. Do I have your attention yet? It's like a stock or bond market, but the tradable securities are forecasts or ideas instead of pieces of companies. I said new but that's only for the business sector: the Iowa Electronic Market has been operating from the University of Iowa predicting elections since 1992, and the Hollywood Exchange (www.hsx.com), a prediction market that helps studios forecast a film's opening and total grosses and even value the contribution of a movie star to a movie has been around since 1996.
Research and Application
Over the last ten years prediction markets have found a home at major companies like Hewlett-Packard, Google, Eli Lilly, Microsoft, GE and Ford predicting product quality issues, validating research questions, project completion dates, technology acceptance rates and new product unit volume or sales revenue. These predictions seem to be especially accurate for short, 12-18 month life cycle products like Hollywood movies, computers and ink jet printers. What's different now is this capability is becoming available to companies of all sizes.
Advancing the Concept
As I show below quite a number of companies are now selling and hosting prediction market services, and a few, like Inkling Markets (www.inklingmarkets.com), have created fast Web 2.0 interfaces and are setting up prediction markets as a SaaS (software as a service). To make traders as efficient and as informed as possible Intrade cleverly shows "the market maker's book", so that traders can see a contract's bid and offer levels higher and lower than the current bid-ask spread. Try getting that out of the NYSE or the NASDAQ without being a member or paying huge monthly fees. One thing doesn't need much predicting: the costs of trialing and deploying prediction markets are declining rapidly.
Setting Up a Prediction Market
What are the important considerations when setting up a prediction market? An article in the November, 2007 issue of California Management Review identified eight.
1. Schedule Market Sessions
2. Recruit Participants and Determine the Budget
3. Determine Number of Competing Ideas
4. Define Demand Outcome Scenarios
5. Design Market Parameters
6. Discover the Winner and Generate Demand Forecasts
7. Determine Participants' Earnings
8. Encourage Active Trading
A Sample of Prediction Market Sites You Can Test Drive
Books
Hahn, Robert W., and Paul C. Tetlock, eds. Information Markets: A New Way of Making Decisions. Washington: AEI-Brookings Press, 2002. (Can be read on line in PDF at no charge at the Brookings Institution website.)
Kambil, Ajit, and Eric Van Heck. Making Markets: How Firms Can Design and Profit from Online Auctions and Exchanges. Boston: Harvard Business School Press Books, 2002.
Surowiecki, James. The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies and Nations. New York: Little, Brown, 2004.
Articles
King, Rachael. "Workers Place Your Bets." Business Week Aug. 4, 2006: p11.
Schonfeld, Erick. "The Wisdom of the Corporate Crowd." Business 2.0, Sept. 2006: p47-49.
Teck-Hua Ho, Kay-Yut Chen. "New Product Blockbusters: The Magic and Science of Prediction Markets. " California Management Review 50.1 (2007): 144-158.
Wolfers, Justin and Eric Zitzewitz. "Prediction Markets. " The Journal of Economic Perspectives 18.2 (2004): p107-126.
Like to receive more on this topic? Please contact Tom Davis
at tdavis@cygnusassociates.com
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