Wednesday, March 19, 2003

Information Markets

Suppose you want to make a prediction on say who will win the Best Actress Award at Sunday's Oscars. You can visit various web sites, look at the predictions of so-called experts, look at polls, etc. Aggregating all of this information to make a single prediction seems quite difficult.

Information Markets do information aggregation by creating financial securities based on the outcome of some event. You can then make predictions based on the prices of these securities. For example, look at the Best Actress page of the Hollywood Stock Exchange. There are five securities listed for each of the nominees. Each security will pay out $25 if that nominee wins and $0 otherwise. At the time I am writing this, the price of the Nicole Kidman security is $13.45. If you take the ratio of the price to the final payoff this gives a probability of winning. For Kidman that would be a $13.45/$25 or 53.8% chance of winning the award.

There are two problems with the Hollywood Stock Exchange. First they don't use real money since that would be illegal in the US. Also the best actress winner has already been chosen so if real money were being used there is the potential for corruption. Nevertheless studies have shown that even such artificial markets still do far better than the experts in predicting the winners.

You can eliminate the problems by considering sporting events on real off-shore betting sites. Sites like Tradesports or the World Sports Exchange have securities (futures) on outcomes based on sporting events that you can look at without registering. In Tradesports consider the security NCAA.BK.KENTUCKY that pays off $100 if the University of Kentucky wins the men's basketball championship and $0 otherwise. The price as I am writing has a bid of $25 and an ask of $26 meaning that Kentucky has between a 25% and 26% chance of winning the NCAA tournament. It will be interesting to see the price and thus the odds change as the tournament progresses. For example if Arizona would be upset in an early round, this should cause Kentucky's price to go up.

Tradesports also has securities in entertainment and political events. On Tradesports Kidman has a bid/ask of $54/$57 not too far off of the Hollywood Stock Exchange.

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