Tuesday, October 10, 2006

Market Power

A recent article in the Op-Ed section of the NY Times argues that law makers shouldn't be so quick to outlaw internet gambling because some of the bets may actually be able to provide useful predictive information not unlike information markets. This article also was also my introduction to the idea of information markets or decision markets. For those of you who don't know what they are I unearth a great article about them entitled "Decisions Decision" from the New Yorker magazine which you can read here.

Apparently internet gambling extends well beyond the world of online poker and casino games. At websites such as tradesport.com one can wager on among other things the outcomes of political races and the weather. Furthermore, regardless of the subject it's more than just an ordinary bet that's being placed upon an outcome. The outcomes are represented by contracts and the forum is modeled after a futures exchange. Participants buy and sell contracts that represent various outcomes. When the outcome occurs the parties to the contract have to perform.

Information markets are supposed to be good predictors because
They are extremely efficient at aggregating information and tapping into the collective wisdom of a group of traders, and groups are almost always smarter than the smartest people in them. As in financial markets, the incentive to get the better of others (whether the reward is profit or mere satisfaction) causes traders to seek out good information. The absence of hierarchy -- markets don'’t have vice-presidents -- —insures that no single person has too much influence and that diverse viewpoints don'’t get shut out.

Decision markets also skirt the political and personal issues that so often clog the flow of information within organizations. Because people are rewarded only for being right, they have no incentive to hide information, pursue agendas, or go along with the crowd.
The Iowa Electron Market is probably the most famous of such a market. It is part educational and research effort at the University of Iowa Henry B. Tippie College of Business and it is being use to study among other things trading behavior and market performance.

Anyway, maybe I've been living under a rock for having no idea that such forums even exist. But, now that I've discovered them I'm not sure what to make of their predictive power or the legal hurdles they present. I'm curious what you all think.


Blogger Luis Villa said...

Erica, you might want to read Cass Sunstein's "Deliberation and Prediction Markets" in "Information Markets: A New Way of Making Decisions". I haven't read it, but I assume it is related to this excellent unpublished paper of his (somehow on Harvard's website), which I found to be a great read and a good introduction to how prediction markets compare with traditional deliberative democratic processes. [Nutshell answer: fairly well.]

10/10/2006 11:34 PM  

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