Dynamic, Objective Probabilistic Predictions
A prediction market is a market for a contract that yields payments based on the outcome of a partially uncertain future event, such as an election. A contract pays $100 only if candidate X wins the election, and $0 otherwise. When the market price of an X contract is $60, the prediction market believes that candidate X has a 60% chance of winning the election. The price of this event derivative represents the imputed perceived likelihood of the partially uncertain future outcome (i.e., its aggregated expected probability). A 60% probability means that, in a series of events each with a 60% probability, the favored outcome is expected to occur 60 times out of 100, and the unfavored outcome is expected to occur 40 times out of 100.
Each prediction exchange organizes its own set of real-money and/or play-money markets, using either a CDA or a MSR mechanism —with or without an automated market maker.
Prediction markets enable us to attain collective intelligence. Prediction markets produce dynamic, objective probabilistic predictions on the outcomes of future events by aggregating disparate pieces of information that the traders bring when they agree on prices. The event derivative traders are informed by the primary indicators (i.e., the primary sources of information), like the polls, for instance. These informed speculators then execute their transactions based on their anticipations about the future —anticipations that will be either confirmed or infirmed.
The value of a set of prediction markets consists in the added accuracy that these prediction markets provide relative to the other meta predictive mechanisms, times the value of accuracy in improved decisions, minus the cost of maintaining these prediction markets, relative to the cost of the other meta predictive mechanisms. A highly accurate set of prediction markets has little value if some other meta predictive mechanism(s) can provide similar accuracy at a lower cost, or if very few substantial decisions are influenced by accurate predictions on its topic.
Although the prediction market technology doesn’t bring omniscience, the prediction markets integrate expectations (informed by facts and expertise) much faster than the mass media do —especially in complicated situations.
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