Prediction markets

April 18, 2008

Tom Davenport has picked up on the question of prediction markets. He is looking for information on use and knowing Tom will do a good job of putting it together so if anyone can help, do! I have mixed thoughts on the subject. Part of that is cynicism about anything with that much hype, especially when the hype doesn’t seem to match up with conversations I have with people in the claimed successful user companies. One of the problems for me is that in a market everyone is aware of other people’s bets and the market therefore will tend to equilibrium. Prediction Markets are not examples of The Wisdom of Crowds whatever Surowiecki says. In fact he seems to contradict himself

His criteria for a crowd to be wise can be summarised as follows:

  1. You need diversity of opinion, each actor needs a private opinion,
  2. Their opinions should not be determined by others, i.e. they should not be following the herd
  3. Participants should be able to draw on local knowledge
  4. There needs to be a mechanism for aggregating the individual decisions to represent the collective.

Now if we look at these we can see that a market satisfies 3&4, to a degree 1 but fails on 2. In a market you are aware of and respond to market movements, so ipso facto you are not making a decision in isolation. So I can’t see why he uses prediction markets in his book.

Of course this does not mean that markets have no utility. However there seems to be a bit of a Hawthorn effect in operation – the case studies seem to be of start ups but with no continuation. I could well be wrong here, but that is the impression I am getting. Markets are there as an way of handling trade, indirectly they may predict but it is not their primary purpose. However I think there are better ways of using crowd wisdom. Distributing part problems to lists of players, engaging social networks on the basis of engagement. Not everything has to be reduced to money surely?

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