1. 15.567 Economics of Information
Prediction Markets
Rodrigo Mazzilli | Damien Acheson | Luis Prata

2. 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

3. 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.

4. 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.

5. Prediction Market Solution Providers
Academic
B2B
B2C

6. 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

7. 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?

8. 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

9. 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

10. Questions & Answers
Thank you! 10