The power of prediction markets

Adam Mann in Nature: “It was a great way to mix science with gambling, says Anna Dreber. The year was 2012, and an international group of psychologists had just launched the ‘Reproducibility Project’ — an effort to repeat dozens of psychology experiments to see which held up1. “So we thought it would be fantastic to bet on the outcome,” says Dreber, who leads a team of behavioural economists at the Stockholm School of Economics.

In particular, her team wanted to see whether scientists could make good use of prediction markets: mini Wall Streets in which participants buy and sell ‘shares’ in a future event at a price that reflects their collective wisdom about the chance of the event happening. As a control, Dreber and her colleagues first asked a group of psychologists to estimate the odds of replication for each study on the project’s list. Then the researchers set up a prediction market for each study, and gave the same psychologists US$100 apiece to invest.

When the Reproducibility Project revealed last year that it had been able to replicate fewer than half of the studies examined2, Dreber found that her experts hadn’t done much better than chance with their individual predictions. But working collectively through the markets, they had correctly guessed the outcome 71% of the time3.

Experiments such as this are a testament to the power of prediction markets to turn individuals’ guesses into forecasts of sometimes startling accuracy. That uncanny ability ensures that during every US presidential election, voters avidly follow the standings for their favoured candidates on exchanges such as Betfair and the Iowa Electronic Markets (IEM). But prediction markets are increasingly being used to make forecasts of all kinds, on everything from the outcomes of sporting events to the results of business decisions. Advocates maintain that they allow people to aggregate information without the biases that plague traditional forecasting methods, such as polls or expert analysis….

Prediction markets have also had some high-profile misfires, however — such as giving the odds of a Brexit ‘stay’ vote as 85% on the day of the referendum, 23 June. (UK citizens in fact narrowly voted to leave the European Union.) And prediction markets lagged well behind conventional polls in predicting that Donald Trump would become the 2016 Republican nominee for US president.

Such examples have inspired academics to probe prediction markets. Why do they work as well as they do? What are their limits, and why do their predictions sometimes fail?…(More)”