Prediction Markets

Summary

This video explores the concept of prediction markets, which are speculative markets designed to make predictions by reflecting information through prices. The speaker explains how prices in various markets, such as orange juice futures and the Iowa Electronic Markets, can predict real-world events, like weather or election outcomes. Unlike traditional markets, prediction markets focus on accurate forecasting. Examples include political predictions and Hollywood movie revenues. By aggregating information, these markets provide insights that can guide decisions in business, politics, and entertainment more effectively than other methods.

Takeaways

• 📈 Market prices can be used as signals to convey information about the value of goods and even predict future events.
• 🍹 The price of orange juice futures, for example, can implicitly predict the weather in Florida because speculators need to predict weather to profit.
• 🔮 Economists often look at market prices to make informal predictions about various events, such as politics or climate change.
• 🌐 Prediction markets are designed specifically for making predictions, with prices interpreted as probabilities.
• 🏦 The Iowa Electronic Markets is a famous example where traders buy and sell shares of political candidates, and the prices predict election outcomes.
• 💼 Traders in prediction markets incorporate their information and opinions into the prices, making them more robust and accurate.
• 📊 The Iowa Electronic Markets have been found to be more accurate predictors of election outcomes than traditional political polls.
• 🎭 Other prediction markets, like the Hollywood Stock Exchange, use speculative trading to predict the success of movies, music, and Oscars.
• 💰 Studios use the information from prediction markets to make casting and production decisions, as they reflect audience anticipation and preferences.
• 📊 The prices in prediction markets aggregate dispersed information and provide a single figure that summarizes expectations and predictions.
• 📉 While not perfect, prediction markets offer a relatively accurate method of forecasting compared to other available measures.

Q & A

What is the primary function of prediction markets?

Prediction markets are designed to aggregate information and make predictions about future events by interpreting market prices as probabilities.

How do prices in prediction markets reflect predictions?

Prices in prediction markets reflect predictions by being based on the likelihood of an event occurring, as determined by the buying and selling of shares by traders.

What is an example of a prediction market?

The Iowa Electronic Markets is an example of a prediction market where traders buy and sell shares of political candidates, and the prices of these shares are used to predict election outcomes.

How does the price of an Obama share in the Iowa Electronic Markets relate to his predicted chance of winning an election?

If Obama has an 80% chance of winning, an Obama share, which pays a dollar if he wins, would be worth 80 cents, reflecting this probability.

Why might someone sell Obama shares even if they believe he has an 80% chance of winning?

Someone might sell Obama shares at 90 cents if they believe the shares are overvalued compared to their predicted worth of 80 cents, indicating a buying opportunity for McCain shares.

What is the role of speculators in prediction markets?

Speculators in prediction markets play a crucial role by incorporating their predictions, information, and opinions into the market prices through buying and selling shares.

How do prediction markets differ from traditional markets?

Prediction markets differ from traditional markets in that they are explicitly designed for the purpose of making predictions, whereas traditional markets have other primary functions.

What is the Hollywood Stock Exchange and how does it function?

The Hollywood Stock Exchange is a prediction market where traders use 'Hollywood dollars' to buy and sell shares and options in movies, music, and Oscar contenders, with prices reflecting predictions about future film profits.

How can studios use the information from the Hollywood Stock Exchange?

Studios can use the information from the Hollywood Stock Exchange to better cast movies, make decisions on future projects, and understand the potential revenue from different actors and directors.

What is the significance of the price changes in the Hollywood Stock Exchange for a movie like 'Fifty Shades Of Grey'?

Price changes in the Hollywood Stock Exchange for 'Fifty Shades Of Grey' reflect changing revenue estimates and the public's anticipation or reaction to casting decisions, which is valuable information for studios.

How accurate are the predictions from prediction markets compared to other methods?

Prediction markets, such as the Hollywood Stock Exchange, have been found to be more accurate than other methods like traditional polls in predicting outcomes such as election results and film revenues.

Outlines

00:00

🔮 Prediction Markets and Their Accuracy

This paragraph introduces prediction markets, which are designed to aggregate information and predict future events through speculative trading. It explains how market prices can reflect predictions about events, such as weather affecting orange juice futures or political outcomes influencing oil prices. The Iowa Electronic Markets are highlighted as a successful example where traders buy and sell shares of political candidates, and the market prices are used to forecast election results. The 2008 U.S. presidential election between Barack Obama and John McCain is used as a case study to illustrate how the market prices can indicate the likelihood of a candidate's victory. The paragraph emphasizes the potential for prediction markets to provide more robust and accurate predictions than traditional methods because they are explicitly designed for this purpose.

05:01

🎬 The Power of Prediction Markets in Entertainment

The second paragraph delves into the application of prediction markets in the entertainment industry, particularly in forecasting the success of movies. It discusses how the Hollywood Stock Exchange uses make-believe currency for trading shares and options in movies, music, and Oscar contenders, with 800,000 traders participating. Despite the fun aspect, the market prices provide valuable insights for studios into potential film profits and the value of casting choices. The paragraph provides an example of how the casting of Charlie Hunnam in 'Fifty Shades of Grey' affected the market prices, reflecting changing revenue estimates. The Hollywood Stock Exchange is portrayed as a tool for studios to make better casting and decision-making choices, as the market prices are more accurate predictors of film revenues compared to other methods. The paragraph concludes by emphasizing the importance of market prices in aggregating and summarizing dispersed information, making them a key figure for predicting future events.

Keywords

💡Market Predictions

Market Predictions refer to the use of market prices to forecast future events. In the video, it is discussed how prices in certain markets, such as orange juice futures, can implicitly predict weather patterns in Florida. This concept is central to the video's theme, which explores how markets can be designed to aggregate information and make predictions about various outcomes.

💡Price Signals

Price Signals are indicators of the value of goods and services. The video explains that prices convey information about where goods have high or low value, and this can even extend to predictions about world events. Price signals are crucial in prediction markets, where they are used to gauge the likelihood of certain outcomes.

💡Speculators

Speculators are individuals who buy and sell assets with the hope of making a profit from changes in their prices. The video mentions that speculators in orange juice futures must make predictions about Florida's weather to profit, thus their actions influence the market prices which in turn reflect their collective predictions.

💡Prediction Markets

Prediction Markets are markets created for the express purpose of making predictions about future events. The video discusses how these markets allow prices to be interpreted as probabilities, with the Iowa Electronic Markets being a prominent example where shares of political candidates are traded to predict election outcomes.

💡Iowa Electronic Markets

The Iowa Electronic Markets is a real-world example of a prediction market mentioned in the video. It is a platform where traders buy and sell shares of political candidates, and the market prices are used to predict election outcomes. This market has been noted to be more accurate than traditional polling methods.

💡Shares

In the context of the video, shares refer to the units of stock that are traded in prediction markets like the Iowa Electronic Markets. The value of these shares is tied to the probability of a candidate winning an election, as illustrated by the example of Obama and McCain shares during the 2008 election.

💡Election Outcomes

Election Outcomes are a key area where prediction markets are used to forecast results. The video uses the 2008 U.S. presidential election between Barack Obama and John McCain as an example to show how the prices of shares in prediction markets can indicate the likelihood of each candidate's victory.

💡Hollywood Stock Exchange

The Hollywood Stock Exchange is another example of a prediction market discussed in the video. Traders here buy and sell shares in movies and celebrities, and the market prices are used to predict box office revenues and the success of films and actors.

💡Futures

Futures are financial contracts that obligate the buyer to purchase an asset or the seller to sell an asset at a predetermined future date and price. In the video, orange juice futures prices are used as an example of how market prices can predict events like weather conditions.

💡Information Aggregation

Information Aggregation is the process of collecting and synthesizing information from various sources. The video highlights how prediction markets aggregate dispersed information from traders and reflect it in market prices, which can then be used to make more accurate predictions about future events.

💡Incentives

Incentives in the video refer to the motivations that drive individuals to participate in prediction markets. The video explains that when real money is at stake, as in prediction markets, people are more likely to carefully consider their predictions and gather as much information as possible, leading to more accurate market prices.

Highlights

Markets can be designed to make predictions.

Prices convey information about world events and future predictions.

Orange juice futures price reflects a prediction about Florida's weather.

Speculators must predict weather to profit from orange juice futures.

Economists use market prices to predict events like Florida weather and Middle Eastern politics.

Market prices are noisy and imperfect predictors.

Prediction markets are designed to interpret prices as probabilities for predictions.

Iowa Electronic Markets is a famous prediction market for political candidates.

Iowa Electronic Markets' prices predict election outcomes.

Market prices reflect traders' information and opinions on election outcomes.

In 2008, Iowa Electronic Markets predicted Barack Obama's win over John McCain.

Prediction markets are more accurate than political polls.

Prediction markets incentivize careful thinking and information processing.

Firms use prediction markets to forecast sales and make decisions.

Hollywood Stock Exchange uses prediction markets for film profits.

Market prices in Hollywood Stock Exchange are valuable for studios.

Market prices aggregate dispersed information into a single figure.

Prediction markets provide relatively accurate forecasts compared to other measures.

Market prices are a good way to convey and summarize information.

Transcripts

♪ [music] ♪

- [Tyler] Today, we look at a new type of market.

A market which has been designed to make predictions.

In previous talks we discussed how prices are signals

that convey information.

Information about where goods have high value

and where they have low value, which goods have high value

and which have low value and so forth.

Prices also can convey information about world events,

even predictions of the future.

So, the orange juice futures price for instance, implicitly contains

a prediction about the weather in Florida.

It's not that these markets were designed for this purpose,

rather it's that speculators, if they are to profit

from movements in the price of orange juice futures,

have to make some predictions about the weather in Florida.

They have to know something about the weather in Florida.

So the price of the orange juice futures,

comes in part to reflect the information that speculators

hold about future weather patterns in Florida.

Indeed, economists and others often have looked informally

to market prices to help make predictions.

To help predict Florida weather, they look to the price

of orange juice in the futures market.

To help predict Middle Eastern politics,

they look to the price of oil and oil futures.

To help predict the consequences of global climate change,

they look to the price of flood insurance

in coastal regions.

Now, in each of these cases, the implicit prediction

is just a by-product of the market and indeed many other things

are going on in these markets which also influence the prices.

The prices in these markets are noisy predictors.

They're rather imperfect predictors because they weren't designed

to only predict.

What would happen if we design the market explicitly

to make predictions?

Then the predictions we got out of the market

might be even more robust and even more accurate.

Let's take a look at some markets which have been designed

to make predictions.

Prediction markets are speculative markets

which have been designed so that the prices

can be interpreted as probabilities and used to make predictions.

One of the most famous of these is the Iowa Electronic Markets.

I encourage you to go to the web and check them out.

Traders on the Iowa Electronic Markets buy and sell shares

of political candidates, and the prices of the shares

can be used to predict the outcomes of elections.

Let me give you an example.

Here's the case of the Iowa Electronic Markets

from the 2008 election between Barack Obama

and John McCain.

In these markets, one Obama share pays you a dollar

if Obama wins and pays you nothing otherwise.

One McCain share pays you a dollar if you hold the share

and McCain wins, and pays zero if he loses.

Now, suppose you think Obama has an 80% chance of winning

that election, how much would you be willing to pay

for an Obama share?

Well, if an Obama share pays a dollar if Obama wins

and he has an 80% chance of winning,

then that share is worth 80 cents.

You would be willing to pay up to 80 cents

for such an Obama share.

Suppose you enter this market and you find

that these Obama shares are selling for 65 cents,

well, that's a buying opportunity.

Something which you think is worth 80 cents

is selling for 65, so then, you should buy Obama shares.

In buying the shares, you would be pushing up their price.

In this way, your predictions, your information, your opinions

about which candidate is likely to win

become incorporated into the price of an Obama share.

By the way, suppose you thought Obama had an 80% chance

of winning but his shares were selling for 90 cents,

well then, you would want to sell Obama shares.

Even if you're an Obama supporter, to make more money

you would sell the Obama shares and buy the McCain shares.

Again, in this way, prices come to reflect the information.

There are lots of traders in these markets.

People who are very politically astute,

who understand the electoral college

and who understand how elections work

and how well or how badly a campaign is going.

When these individuals buy and sell shares,

their information comes to be reflected

in the market prices.

Here are the actual prices on August 8th, 2008.

Obama shares were selling for 63 cents per share

and McCain shares were selling for 37 cents.

The market was predicting a high likelihood of an Obama win

and in fact, that did, of course, turn out to be the case.

In over 20 years of testing these markets,

in presidential elections, congressional elections,

and state elections, these market prices

from the Iowa Electronic Markets have turned out

to be better predictors of the outcomes

than have political polls.

That makes a lot of sense. Think about it.

With real money on the line, people have an incentive

to think carefully when they're investing

and they have an incentive to collect and process

and interpret all of the information

from available all over the world.

The resulting market prices reflect a lot

of deep-seated information and indeed interpretation

in a way which political polls simply cannot.

Similar prediction markets have been creating

all kinds of things.

Some are pretty trivial things, such as which actor or actress

is going to win the next Oscar, but also, firms have begun

experimenting with prediction markets to help

from forecast variables, like their future sales

or which is the better decision, or what will happen

in some particular market or some particular economy.

Firms have been using prediction markets

to try to help themselves make better decisions.

Let's give an example.

At the Hollywood Stock Exchange, traders buy and sell shares

and options in movies, music, and Oscar contenders.

Some 800,000 traders do this for fun.

They're using make-believe "Hollywood dollars"

but they still care enough about the outcome

to make the prices in these markets pretty reliable predictors

of future film profits.

Now, although the traders are doing this for fun,

the website is owned and run for profit.

The information, the implicit predictions

in these prices, that's valuable to studios

who want to try and understand what's going to work

in their next film and what's not going to work.

Here is an example.

Some of us may believe that sex sells,

but is that actually the case?

Well, on the Hollywood Stock Exchange,

we can be much more precise using market prices.

Here is some of the trading for the movie

"Fifty Shades Of Grey" and you can see the price

made a whole bunch of leaps up and then leaps downward.

That's reflecting changing revenue estimates for the movie.

A leap up came when Charlie Hunnam was cast

to play the title role in the movie and then the price did go up.

Later on, Charlie dropped out and the price dropped

right back down again.

The prices in these markets are important information

for the studios.

They tell the studios how much are these actors really worth.

If we hire this actor, how much will revenue

for the movie go up?

Are people excited about a particular actress

in a particular role, what about the director?

By using the information and the prices

from the Hollywood Stock Exchange, studios are able to better cast

their movies and they can make better decisions.

No prediction process has perfect accuracy,

but the prices from the Hollywood Stock Exchange

turn out to be pretty useful, especially when compared

to other methods.

Along here, we have predicted opening revenues as shown

by the prices on the Hollywood Stock Exchange,

and then here we have actual revenues.

If the predicted revenues always equal the actual,

well then, everything would be along the red line.

When the actual revenues turn out to be more

than predicted, we're above the red line.

So the original movie, "Kings Of Comedy",

was a smash hit because it did much better than predicted.

The movie, "The Adventures of Pluto Nash" with Eddie Murphy,

well that was a disaster.

It did much worse than predicted.

On average however, the predicted revenues

are pretty good indications

of what the actual revenues would be.

And again, that's why the studios look at these market prices

because they are relatively accurate predictions,

more accurate than other available measures.

Alright, let's conclude.

Market prices reflect information and they convey information.

Prices in futures markets, can signal all kinds of things

such as war in the Middle East, cold weather in Florida,

or who will win the next election.

Prediction markets are new types of markets

which have been created to help businesses, governments,

and scientists predict future events.

Market prices are good ways

of aggregating dispersed information

and summarizing that information in a single key figure, the price.

Thanks.

- [Narrator] If you want to test yourself,

click Practice Questions,

or if you're ready to move on, just click Next Video.

♪ [music] ♪