About Prediction Markets
What is a Prediction Market?
A prediction market aggregates opinions from multiple people regarding future events by allowing them to match opposing stakes at variable odds over time. A prediction exchange’s market-setting mechanism is the same as how the stock market determines the price of a company’s shares traded on the stock exchange. Predictors (stock traders) use deep knowledge of a company and its commercial prospects to predict rising or falling fortunes in the future, and thereby decide whether to buy or sell shares in that company at a specific time and price.
How is a Prediction Market different from an Opinion Poll?
Opinion polls are a time-tested method for assessing public sentiment leading up to various events, including political elections. Top pollsters are names most people recognize: Gallup, Zogby, Ipsos, Pew, Field. Polling experts typically probe a ‘representative sample’ of the public to understand their attitudes, beliefs and hopes for the future. They ask about their preference among candidates in an upcoming election. They analyze and interpret responses and publish an extrapolation or forecast of the outcome of the future event.
While data-rich and interesting, opinion polls can have a vulnerability often overlooked. They gather many interesting facts and statistics to infer the future but usually fail to ask the Question That Matters Most (QTMM): “Who is going to win?” This question is very different from the more commonly asked question, “Who are you likely to vote for?”
There is power in asking the QTMM—it strips away many personal biases, committing a respondent to correctly guess one of two possible outcomes regardless of whether it’s the outcome they personally favor.
For example, ask a thoughtful Ron Paul supporter which presidential candidate has the political experience, policies and leadership skills to meet the needs of the US over the next 4 years and she would surely name Dr. Paul. However, ask her which candidate will win—and be sworn in as the next US President next January (the QTMM)—and she is sure to name either Senator Obama or Senator McCain.
Personal beliefs, opinions and preferences are often closely held and may not change in response to facts and current events. Predictions about a discrete future event often change in response to new information, so answers to the QTMM can vary leading up to the actual event.
Why are Commercial Prediction Markets more accurate?
A commercial prediction market is simply one in which there is an economic incentive to guess correctly. Stock markets are massive commercial prediction markets for which there are hundreds of models used by thousands of analysts to process dozens of data sources to help guess correctly—because the stakes are high.
“The power of prediction markets derives from three simple forces. First, by forcing you to “put your money where your mouth is,” they yield truthful revelation of beliefs. Second, markets provide profit opportunities for those willing to gather new information that helps predict the future. And third, markets aggregate information dispersed across many traders.”
Source: Stanford Institute for Economic Policy Research Policy Brief: Pricing Political Risks with Prediction Markets, Justin Wolfers, June 2004
Because participants in commercial prediction markets have a real financial stake in the outcome, they have an incentive to guess accurately and to update their guess as quickly as possible in light of new information that may arise. The participant who processes new information the fastest using the best analytical algorithm has an advantage in the market.
Why is Betfair the world’s leading Commercial Prediction Market?
Betfair is the largest commercial prediction market in the world with 2007 transaction value of approx. USD $28 billion. Betfair delivers more than 4 billion page impressions per week and processes more than 5 million commercial transactions a day for more than 2 million registered users.
According to Prof. Leighton Vaughn-Williams, Editor of the Journal of Prediction Markets, Univ. of Buckingham Press and Professor of Economics and Finance at the Nottingham Business School, “Liquidity is the key to the accuracy of betting sites.”
Betfair takes a strong stand against fraud and for fairness and integrity in all of its business dealings and in the online markets it operates. Betfair welcomes regulation and is committed to strict adherence to applicable laws in every market in which it operates. Betfair does not currently operate betting markets in the US.