NCPA - National Center for Policy Analysis


December 14, 2004

Prediction markets allow participants to trade stock on a certain event's outcome. For example, there are markets where people trade on who will win the World Series, who will win the presidential election and who will win the Oscars. According to a new paper from the National Bureau of Economic Research (NBER), these markets can be quite accurate.

  • The Iowa Electronic Market predicted presidential elections with an absolute margin of error around 1.5 percentage points, while the reputable Gallup poll projections erred by 2.1 percent.
  • The Hollywood Stock Exchange has proven highly accurate at predicting opening weekend box office success and Oscar winners.

The authors also argue that prediction markets do not need to be large to be effective. They can utilize a small population, internal to a business. For example:

  • An internal market at Hewlett-Packard produced more accurate forecasts of printer sales than did the firm's internal processes.
  • Another internal market at Siemens predicted the firm would definitely fail to deliver a software project on time, even as traditional planning tools said the deadline could be met.
  • In each firm, the traders numbered only between 20 and 60 employees.

The authors note that prediction markets have limits. They can predict certain events better than others. Nevertheless, they believe that these markets are extremely useful for estimating the market's expectation of certain events.

Source: Matt Nesvisky, "Markets Can Predict the Future," NBER Digest, November 2004; based upon: David Cutler, Robert Huckman and Mary Beth Landrum, "The Role of Information in Medicinal Markets: An Analysis of Publicly Reported Outcomes in Cardiac Surgery," National Bureau of Economic Research, Working Paper No. 10489, May 2004.

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