A number of financial markets allow investors to make predictions about future price and risk developments: for example, anyone who buys a share thinks that the price will rise.
There are also “futures” markets that allow someone to deliver a specific item for a specific price at some point in the future. Some futures markets are based on financial prices such as the price of the Standard & Poor’s stock market index; others are based on the prices of physical goods like oil, gold, wheat, soybeans, and many others.
When economists speak of a “predictive market,” they mean a market where people buy and sell based on future events rather than expectations of future prices. One of the most famous examples is the Iowa Electronic Markets, where you can place small bets on the outcome of elections and related events. Rising or falling prices in this market can then be used as a measure of the likelihood of voting.
But in the early 2000s, the idea of using forecasting markets more widely took a serious blow in public relations. Justin Wolfers and Eric Zitzewitz tell the story in their article “Prediction Markets” in the Spring 2004 issue of the Journal of Economic Perspectives (where I work as Managing Editor). They write:
In July 2003, press reports began on a project by the Defense Advanced Research Projects Agency (DARPA), a research think tank of the Department of Defense, to establish a policy analysis market that would enable trading in various forms of geopolitical risk. The proposed treaties were based on indices of economic health, civil stability, military disposition, conflict indicators, and possibly even specific events. For example, contracts could be based on questions such as “How fast will Egypt’s non-oil production grow in the next year?” or “Will the US military pull out of Country A in two years or less?” In addition, the exchange would have offered combinations of contracts, perhaps a combination of an economic event and a political event. The concept was to find out whether trading such contracts could help predict future events and how relationships between events are perceived. However, political turmoil ensued. Critics enraged DARPA for proposing “terrorism futures” and instead of spending political capital on defending a tiny program, the proposal was dropped.
After this experience, prediction markets continued to exist, but mostly in small and limited forms. For example, as an experimental market specifically designed for research and teaching purposes, the Iowa Electronic Markets is limited in size. For large companies like Google and Ford, it is now common practice to operate “internal” forecasting markets where internal company bets can be made on whether project deadlines or sales targets will be met; It often turns out that the feedback from the Internal Market is a useful corrective to managers’ promises that everything will be going well. On the Hollywood Stock Exchange, you can bet on how many sales a movie will be in the weeks following its release. Of course, Americans can also bet on different outcomes by using better markets in other countries – or simply watching those markets to see what news they are sending.
But now there are some signs that US forecasting markets have never entirely gone and may be ready to move up again. Mary Brooks and Paul Rosenzweig tell the story in “Let’s Bet on the Next Big Policy Crisis – No, Really” (Lawfare blog, July 13, 2021). They point to some new academic experimentation beyond the longtime Iowa Electronic Markets:
More recently, Georgetown University has developed its own crowd forecasting platform – which is not a pure forecasting market, but a way of collecting and bundling expert opinions – especially for geopolitical futures. Likewise, Metaculus offers a platform for a quasi-predictive market where the currency is prestige points and anyone can ask a question about admission to the market.
They point out that the use of internal markets for company forecasting has increased and there is indeed a market for those who are top secret in the U.S. intelligence community:
[T]There is considerable demand here for in-house forecasting markets and crowd forecasting. Google, Ford, Yahoo, Hewlett-Packard, Eli Lilly, and a number of other prominent companies have operated or continue to operate a corporate market. Some of their questions may be about geopolitics, but for the most part, employees are betting on topics like meeting deadlines, which products will prevail, and which profit slips will fail. …
For example, in 2010 the secret service launched a prediction market for top-secret government employees on its classified networks. From 2011 to 2015 the Intelligence Advanced Research Projects Activity (IARPA) – the intelligence service sister of DARPA – carried out the Aggregative Contingent Estimation (ACE). ACE was a project aimed at “dramatically improving the accuracy, precision, and timeliness of intelligence forecasts … [by means of] Techniques that produce, weight and combine the judgments of many intelligence analysts. ”Today, IARPA still conducts the Hybrid Forecasting Competition, the[s] and test[s] hybrid geopolitical forecasting systems. ”
But perhaps most interestingly, there is now a company called Kalshi that is licensed by US government agencies that allows trading in the outcome of events. Brooks and Rosenzeweig write:
A forecast market that functions as a real financial exchange opened its digital doors only last week. Kalshi – a San Francisco-based startup currently in beta – is the first fully regulated (CFTC-approved) prediction market. Because Kalshi is regulated, larger amounts of money can be wagered than many other markets, allowing them to create a new asset class of event futures. The implications for this are obvious: Such an asset class could serve as an alternative or supplement to traditional insurance and enable companies and individuals to protect themselves against crop failures, cyber attacks or floods.
It is of course easy to raise concerns about the predictive markets. Will they allow some people to benefit when an unpleasant event occurs? Yes, but so do any number of perfectly legal investments that can be made in other financial markets (such as insurance company stock prices). Can they be played by investors? While a group of investors can certainly drive the price one way or the other, the ultimate question is whether or not the event will actually happen. Those trying to drive the predicted market price to strange places must be willing to lose money.
Nobody says that the market forecast is perfect: in sports betting, for example, the favorite does not always win. But predictive markets provide a way to bring together information and beliefs from a wide variety of people, rather than relying on other imperfect predictive methods like listening to insider experts, outside experts, or survey data. If you think that the probability of a future event contained in the predicted market prices is wrong, then that’s okay; Are You Ready To Build Your Faith With Real Money? If you feel uncomfortable about this, you might want to reconsider how much you hold onto this belief.