Betting Markets Work
November 14, 2003
The Policy Analysis Market (PAM) was to have been a market in which participants could wager on Middle East events -- say, the gross domestic product of Syria in coming years or the political stability of Iran.
Critics labeled the project a "terrorism futures market" and denounced it as morally repugnant and grotesque, but the concept rests on solid scientific foundations. Work begun by economist Vernon Smith and other in the 1960s has shown that carefully designed markets can be among the most effective prediction tools. They can allow many, physically isolated individuals to share, aggregate and evaluate knowledge. For example:
- Orange juice futures predict the weather in Florida better than conventional weather forecasts do.
- On the day the space shuttle Challenger exploded in 1986, Wall Street traders correctly guessed within minutes of first hearing the news which of the four main suppliers had provided the faulty part, whereas a blue-ribbon panel of experts took months to come to the same conclusion.
- The New York Stock Exchange (and many others around the world) distills the collective wisdom of millions of individuals into a single statistic, and they do so with amazing efficiency.
- The Web-based Hollywood Stock Exchange correctly guessed 35 of last year's 40 Oscar nominees in the main categories.
- The Iowa Electronic Markets have predicted the outcomes of presidential races better than 75 percent of the polls.
- And in a recent trial, a market specially designed to predict sales of Hewlett-Packard products performed better than the company's internal sales forecasts.
In contrast to other information-gathering institutions, such as committees and polls, markets require participants to put hard dollars behind their opinions. What's more, markets reward the people who are right, not those who lie convincingly or are loudest or most aggressive or who have the longest string of titles after their name.
Source: Erica Klarreich, "Best Guess," Science News, October 18, 2003.
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