15.567 Economics of Information Prediction Markets Rodrigo Mazzilli | Damien Acheson | Luis Prata

Prediction Markets Purpose Produce dynamic probabilistic predictions of future events; Participants trade in contracts whose payoff depends on unknown future events; The market price will be the best predictor of the event; Example: Contract pays $1 if Hillary Clinton is elected Market Price is $0.78 Prediction is 78% likelihood of Hillary becoming President

Prediction Markets Accuracy Evidence shows that Prediction Markets give better predictions than other less sophisticated tools (i.e. opinion surveys or experts) Example 1: Markets vs Polls in 41 elections Average error: Markets (1.49%), Polls (1.93%) Joyce Berg, Robert Forsyth, Forrest Nelson, Thomas Rietz, “Results from a Dozen Years of Election Futures Market Research, University of Iowa (November 2000) Example 2: Markets vs 1947 Experts in 208 NFL games Rank: Markets (6th) vs Avg Experts (39th) Emile Servan-Schreiber, Justin Wolfers, David Pennock and Brian Galebach,”Prediction Markets: Does Money Matter?”, Electronic Markets, 14(3), September 2004.

Prediction Markets Why they work? The use of (play) money in trading contract prices incentives: Truthful revelation – behave accordingly with convictions; Information discovery – seeking and researching info; Aggregation of information – weighted collective view; The quality of the prediction depends on: Clear definition of the contract/event; Incentive to Trade; The quantity of performed transactions; Disperse information.

Prediction Market Solution Providers Academic B2B B2C

Prediction Markets Solution example: HP BRAIN Proprietary algorithms which weight individual’s forecast according to predictive ability and behavioral profile Forecasting accuracy with a small set of participants (10-20 people) Removes personality, hierarchy, and bias Improves business prediction in enterprises Sales, revenues, operating profits probability of a successful product product delivery dates other quantifiable business metrics

Prediction Markets HP BRAIN and business questions Sales Forecast Marketing scenario “X”, with no changes in sales force alignment, will increase product sales by “Y”% in the next 6 months ? What will product sales reach in US$ by the end of this year? Revenue Forecast What will the 1st quarter revenues be? (revenue choices must be created ) What will the 1st quarter operating profits be? Will the new vehicle model X achieve sales of 5,000 units in its first month? Product Success In US, 3 months after launching IPTV, the subscriber penetration rate will be? If we modify the clinical protocol for scenario B when will we be able to show drug efficacy?

Prediction Markets Case example: HP Services Predict month-to-month operating profits and revenues 14 finance executives from various regions and levels 3-hour training (now greatly shortened) 49% improvement in operating profit predictability

Prediction Markets Case example: DRAM pricing Accurate prediction of DRAM prices is critical Very volatile pricing Pricing team discussions in the 1-, 3-, and 6-month time frames 20+ prediction sections beat the normal process 13 times tied 3 times 37% improvement over existing systems Less time and less frequent iterations

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