Chris M., I considered the possibility that the authors were using the term “averaging” in sort of a casual way to mean “some sort of tool for combining information.” The also say things like “forecast pooling” and “some function of each individual forecast” which doesn’t commit them explicitly to averaging as the method. But immediately after those more general references they jump into an explicit discussion of the problems of averaging, so I conclude that averaging is their focus.

Chris H., the Porter and Oprea reference is interesting, I just vaguely remember the paper and will have to go back and read it. But we can distinguish between how, behaviorally, people interpret market price sequences and the relation between market price sequences and event outcomes. Both halves of this distinction are potentially interesting.

Paul, you are right that I was thinking of a double auction style prediction market, and there are other market designs also of interest.

On the question of ‘who should be invited to participate,’ my inclination is to want to take as many people’s money as possible, so let everyone in. You might have intended the question more analytically – companies with internal prediction markets presumably have to address this question and it may make a difference in outcomes. I don’t know whether this issue is addressed in published studies.

You’re right that it’s harder to get significant participation in PMs that concern distant events, but it can be done. And if you don’t do it, you uncouple the betting from outcomes, which will of course make the predictions much less useful.

Part of the trick in designing useful markets is to come up with outcomes that can be determined for certain at some point. So the level of the S&P will be known for sure, but unemployment isn’t final until sometime after the date concerned. FX usually does pretty well. HSX has something that can be predicted, IEM doesn’t have any problems (though rarely, the market can’t be closed on time due to challenges of results.) You just have to find something where an answer is usually available close to the closing time.

Any information aggregator.

Who’s to say which figure should be used for the payoff. It could be that the prediction market is simply trying to predict the future estimate. Hardly valuable. To be useful, the predictions need to be made well in advance, but most participants will not be very interested in these long-term decisions.

Finally, who should be invited to participate? Joe six-pack? Economists? Politicians?

“Since the “prediction” implied by a prediction market is set by the marginal transaction, it depends not at all on the distribution of earlier trades, nor on the valuations of parties priced out of the market at the current price.”

This is true for some markets, but not all. Consider a winner-take-all market, similar to many on Hubdub. These PMs function more like parimutuel betting. The most recent bet on a state is added to all previous bets, readjusting the odds for all states. This is much different than the case where the most recent trade sets the market price.

Perhaps the best way to get the market prediction is to obtain the mean from the distribution of outstanding shares when the market closes. You can also obtain the distribution for use as a measure of uncertainty.

They are “way off base” in theory but not in practice. Wait till Daniel Reeves’ paper comes out.

Why do they put “toddlers” into that???

Traders are not toddlers. Why *toddlers*?

Are they being mean towards the traders or do they have a bigger picture to convey in their conclusion that I missed?

However, they say, “can be viewed as”… vague enough… That is not untrue if you consider the outcomes of each of these 2 collective forecasting techniques. They are very close. The improvement brought by prediction markets is quite small (if any) —ask Yahoo! Research’s Daniel Reeves.

So I would agree with their language: …”can be viewed as”… The outcomes are very close… even though the aggregation information mechanisms are different.

The best description I’ve seen of how to interpret the actual outcome was in some experiments done by Dave Porter, and Ryan Oprea, in which they had non-trading judges watch the ticker and estimate the actual value of the goods. The real answer is that the meaning of a market is how an observer would interpret it. In your first case, if all the trades at .50 happened a week before closing, and the only recent trade was at .75, that means something very different from if all the .50 trades were spread evenly over a long period, and there was one trade at .75 just before closing. In the latter case, many observers would say the market really believed the price was .50, and someone had snuck in a wild trade at the end.

Of course, in both these examples, I’m agreeing with Giberson that Hendry and Reade are way off base in describing PMs as an averaging process.