I though this may be interesting to users of the simExchange as we are a prediction market and this article is all about prediction markets.
It is in the June 2008 issue of WIRED. The article is fairly long to type out, so I have selected a few tidbits from the article below. If you want to read the rest of the article, it can be found in the June 2008 issue of WIRED or wait for WIRED to make the article available online.
“Like financial markets, prediction markets are big information processors, distilling the collective wisdom of their traders. But the success of any market depends upon the stakes and the pool of traders. Most prediction markets aren’t anywhere near as robust as those they emulate on Wall Street. ‘They are thin, trading volumes are anemic, and the dollar amounts at risk are pitifully small,’ market analyst Barry Ritholtz wrote in January. That opens them up to all kinds of problems as information processors.”
“So how can prediction markets be rectified? For starters, they need to have real stakes. There is some debate about whether this means money or something else, like reputation.”
“Beyond this, it’s important to improve the pool of traders. According to economists, this requires a certain alchemy of expertise and stupidity. With more experts and insiders, the markets can get out ahead of conventional wisdom. But forecasting also needs more so-called noise traders, who do business with almost no information. Noise traders boost accuracy by increasing volume and the potential profits of informed traders.”
“Diversity helps, too. If you can get different types of people to play, experts say not only do you get a bigger pool and more information, but differing random guesses will cancel each other out, leaving real signals to rise above the noise. Plus, if you have a critical mass of investors with a variety of backgrounds, locations, and interests, they are less likely to move as a herd.”
“…pay attention to whether a given market is likely to have a good variety of traders and that they’re playing for something meaningful. If not, stay away. Unless, of course, you happen to have some inside information yourself. In that case, by all means jump in and clean up.”
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It is in the June 2008 issue of WIRED. The article is fairly long to type out, so I have selected a few tidbits from the article below. If you want to read the rest of the article, it can be found in the June 2008 issue of WIRED or wait for WIRED to make the article available online.
“Like financial markets, prediction markets are big information processors, distilling the collective wisdom of their traders. But the success of any market depends upon the stakes and the pool of traders. Most prediction markets aren’t anywhere near as robust as those they emulate on Wall Street. ‘They are thin, trading volumes are anemic, and the dollar amounts at risk are pitifully small,’ market analyst Barry Ritholtz wrote in January. That opens them up to all kinds of problems as information processors.”
“So how can prediction markets be rectified? For starters, they need to have real stakes. There is some debate about whether this means money or something else, like reputation.”
“Beyond this, it’s important to improve the pool of traders. According to economists, this requires a certain alchemy of expertise and stupidity. With more experts and insiders, the markets can get out ahead of conventional wisdom. But forecasting also needs more so-called noise traders, who do business with almost no information. Noise traders boost accuracy by increasing volume and the potential profits of informed traders.”
“Diversity helps, too. If you can get different types of people to play, experts say not only do you get a bigger pool and more information, but differing random guesses will cancel each other out, leaving real signals to rise above the noise. Plus, if you have a critical mass of investors with a variety of backgrounds, locations, and interests, they are less likely to move as a herd.”
“…pay attention to whether a given market is likely to have a good variety of traders and that they’re playing for something meaningful. If not, stay away. Unless, of course, you happen to have some inside information yourself. In that case, by all means jump in and clean up.”