All seeing all knowing
Futures markets can help identify successful products, predict revenues, and even forecast whether Bush or Kerry will win in November
The Pentagon came under fire last summer for its plan to launch a futures market where traders could wager on the likely occurrence of various economic and geopolitical events in the Middle East, including terrorist acts. The program's goal was to harness the predictive powers of markets in order to get a better analytical handle on a maddeningly complex region of the world--and perhaps prevent another 9/11. But whatever the intent, to many observers the whole idea seemed in poor taste. When plans for the Policy Analysis Market hit the news, headline writers quickly dubbed it "the terror market," and New York Sen. Hillary Rodham Clinton branded it a "futures market in death." But supporting the adage that there's no such thing as bad publicity, prediction markets live on--in the private sector.
"There has been a huge surge of interest since the Pentagon controversy last year," says Emile Servan-Schreiber, CEO of NewsFutures, a firm that develops prediction markets for businesses. "These markets got killed politically, but intellectually there was a huge rally in the defense of them, and we started fielding a lot of leads from companies who wanted to try this." Among the firms tinkering with prediction markets to help their decision making and forecasting are Eli Lilly, HP, and Dentsu, Japan's largest advertising agency. In the future, these markets could help forecast everything from corporate earnings to drug approvals to employee retention rates.
Executives at those companies apparently dissent from Danish existentialist philosopher Soren Kierkegaard, who wrote, "Wherever the crowd is, there is untruth." At the heart of these markets is the belief that there is plenty of truth to be found in crowds, that the wisdom of many is often superior to that of one, even an expert. The problem, though, is determining the consensus opinion. This is where prediction markets come in. "There's an old saying that 'All of us know more than any of us,' " says Thomas Malone, a professor at the Massachusetts Institute of Technology's Sloan School of Management and author of The Future of Work, which, among other things, explores the value of prediction markets to business. "Prediction markets help make this old saying a reality. They combine what lots of individuals know into a single consensus view that is usually much more accurate than any of the individual views."
With prediction markets, also called "betting markets" or "idea markets," the current odds or price levels constitute the best available consensus about a particular question. Some of the most well-known and accurate prediction markets are the Iowa Electronic Markets, run by the University of Iowa's business school, where traders speculate about a variety of political and financial forecasts. With IEM's Presidential Vote Share Market, for instance, political junkies can invest as much as $500 in futures contracts based on what percentage of the popular vote President Bush and Sen. John Kerry will each get on Election Day. Currently, each $1 contract is going for around 50 cents, which means the market is predicting a dead-even contest (chart, Page 56).