Working Paper: CEPR ID: DP5578
Authors: Justin Wolfers; Eric Zitzewitz
Abstract: Prediction Markets, sometimes referred to as 'information markets', 'idea futures' or 'event futures', are markets where participants trade contracts whose payoffs are tied to a future event, thereby yielding prices that can be interpreted as market-aggregated forecasts. This article summarizes the recent literature on prediction markets, highlighting both theoretical contributions that emphasize the possibility that these markets efficiently aggregate disperse information, and the lessons from empirical applications which show that market-generated forecasts typically outperform most moderately sophisticated benchmarks. Along the way, we highlight areas ripe for future research.
Keywords: event futures; forecasting; futures; information aggregation; information markets; prediction markets
JEL Codes: C53; D8; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| prediction markets (G13) | efficiently aggregate dispersed information (D83) |
| traders with log utility (L97) | prediction market prices reflect mean beliefs of traders (D41) |
| beliefs about probability of an event independent of wealth (D81) | equilibrium price equals average belief among traders (D41) |
| wealth correlated with beliefs (D63) | market price represents wealth-weighted average of beliefs (G19) |
| trading profits (F19) | incentive for information discovery (D83) |
| manipulation attempts in prediction markets (G41) | typically fail (Y40) |
| prediction markets (G13) | accurate forecasts (C53) |
| prediction markets (G13) | outperform traditional prediction tools (C52) |
| favorite-longshot bias (G41) | affect accuracy of low-probability event predictions (D80) |