Prediction Markets – A valuable tool for executive decision making, lowering cost and increasing accuracy.

Prediction markets are speculation hubs where traders predict future events such as election outcomes (Obama against McCain) or on economic outcomes, such as the US hit by recession or the Federal Reserve prediction and so on. The markets employ the “wisdom of crowds” theory to produce dynamic, probabilistic predictions combining the collective knowledge of many individuals who adopt different perspectives. They are beginning to be employed to obtain information about all kinds of events, from terrorist attacks to naturally occurring incidents such as flu epidemic.

Individuals place bets on questions ranging from “Will the US enter recession in 2008?” to “Where will the next hurricane make landfall?” Some of the best online markets include the Lowa electronics markets, Yahoo tech buzz game and Public Gyan. In trade, run by trade exchange network, an Irish firm has earned $76 million of bets this year. Its data have reportedly being used by American commodities futures trading commission, the United States navy, various Federal Reserve banks, and the European central bank to forecast everything from elections to business successes and failures.

Theoretical Base

Prediction markets can be defined as agreements where individuals trade contracts, and payoffs are associated with efficient forecast of certain predetermined events in the future. These markets aggregate disparate pieces of information to produce market generate forecasts and have typical outperformed opinions. These were found to be more accurate than professional pollsters or market researchers. At the heart of these markets is the belief that it is the best method for aggregating opinions of large groups of people and come up with forecasts of events in the real world.

Their principles is much like futures markets , where prices of contract is based on a collective day-to-day judgment either on a straight number, sales forecast, or a probability measured as a percentage.

Commercial Use – Who’s already using it?

Today, prediction markets have moved from general election predictions to other industries like retailing, consumer packaged foods, hotels, healthcare, steelmaking and telecommunications. In the last four years, dozens of major corporations began experimenting with prediction markets to try to reduce risk and accelerate innovation by tapping into the collective wisdom of the workforce. The companies which have joined the club includes Cisco Systems, Microsoft, General mills, Arcelor Mittal, HP, Yahoo and many more. They have also been applied to predict Fed policy action, leading economic indicators, stock prices etc. at the same time, a network of software and service-suppliers like Consensus point and News futures has been working on techniques and software to help companies set up predictions markets.

Outperforming other forms of forecasting

One of the most well known and accurate prediction markets is the University of Iowa’s, Iowa electronic market (IEM). IEM was found in the year 1988 and has an exceptional track record in predicting the results of American Presidential elections better then major National polls.

Prediction markets have generated a great interest in recent years as they react extremely quickly to news. This enables participants to obtain an immediate idea of breaking events. It has been reported that they were 70% more accurate than the company’s traditional forecast models. Now they are increasing under intense research in various fields ranging from economics to political science to computer science. In denouncing prediction markets as wrong, many miss the logic that they are a useful window, providing the guess of a group as to the probability of occurrence of future events.

Scope - ImmenseSmartly applied, the information gleaned from prediction markets help

managements listens to the voices in the company that might otherwise go unheard.

Further sources to learn about Prediction Markets:

1. http://www.aeaweb.org/annual_mtg_papers/2006/0106_1015_0703.pdf

2. http://en.wikipedia.org/wiki/Prediction_markets3. http://

bpp.wharton.upenn.edu/jwolfers/Papers/InterpretingPredictionMarketPrices.pdf

4. THE WISDOM OF CROWDS by James Surowiecki.