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Prediction Markets and the Wisdom of the Crowds

Prediction Markets and the Wisdom of the Crowds. Presented by: Kaitlin Santanna & Eva Budzynski. A quick experiment… . How many jelly beans are in the jar?. ?. The Wisdom of the Crowds. As we saw from the two averages, the predictions of the group as a whole was better than one single guess

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Prediction Markets and the Wisdom of the Crowds

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  1. Prediction Markets and the Wisdom of the Crowds Presented by: Kaitlin Santanna & Eva Budzynski

  2. A quick experiment… • How many jelly beans are in the jar? ?

  3. The Wisdom of the Crowds • As we saw from the two averages, the predictions of the group as a whole was better than one single guess • This idea was the inspiration for John Surowiecki’s book “The Wisdom of the Crowds” • Good because asking a diverse group of people • Bay of Pigs • Traffic • How can this idea be applied to the finance world?

  4. Prediction Markets • A speculative market whose purpose is to make predictions • Assets’ final cash value is tied to the outcome of a particular event • The current market prices are interpreted as predictions of the probability of the outcome of this event

  5. Who uses prediction markets? • Major corporations • Yahoo, Microsoft, Google • Sales, product behavior • Public opinion • Educational institutions • You!!!!!

  6. Prediction Markets Make It Big • The value and effectiveness of prediction markets was first known in 1988 • Iowa Electronic Market (IEM) • Created by the University of Iowa’s business school • Features a host of markets designed to predict outcomes of elections • Has correctly predicted the outcome of elections better than traditional polling

  7. Iowa Electronic Market • Open to anyone who wants to participate • Allows people to buy contracts based on how they think a particular political candidate will do • Two most common contracts • Predict winner of election • Predict what percentage of final popular vote candidate will get

  8. Predict the Winner • Cash-or-nothing format • For example, if you picked George Bush to win the 2000 election, you would have bought a “GWB to win” contract that paid you $1 • If he had lost, you would have gotten nothing • Price you pay for this type of contract reflects market’s judgment of candidate’s chance of victory • If contract is $.50, market believes has 50% of winning

  9. Predict the Percentage • Predict the percentage of the final popular vote a candidate will get • Payoffs are determined by the vote percentage • If you bought a GWB contract in 2000, you would have received $.48 (since he won 48% of the popular vote) when the election was over

  10. IEM 2008 Example • 2008 Presidential election • Vote-Share Market (PRES08_VS) • Determined by the percentages of the popular vote received by the Democratic and Republican nominees • Opened on Thursday, June 1, 2006 • Payoff: • Payoffs are determined by the percentages of the total two-party popular vote • E.g., contracts for a candidate who receives 32.4% of the popular votes will be worth 32.4 cents each

  11. IEM Example (cont’d) • Results • The Friday, November 7, 2008, New York Times was the official source used to determine payoffs • IEM data on website http://iemweb.biz.uiowa.edu/pricehistory/PriceHistory_GetData.cfm • November 7, 2008, last trade before midnight

  12. PRES08_VS Graphs http://iemweb.biz.uiowa.edu/graphs/graph_Pres08_VS.cfm

  13. IEM’s Accuracy • Berg, Forsythe, Nelson and Rietz’s article “Results from a dozen Years of Electronic Futures Market Research” • IEM’s performance in 49 elections from 1988-2000 • Election-eve prices in the IEM were off by: • 1.37% Presidential • 3.43% Other U.S. • ¾ of the time, IEM’s market price was more accurate • Less volatile and change only in response to new information

  14. Hollywood Stock Exchange • HSX – www.hsx.com • The entertainment stock market where you can trade movies, stars, and more just as you would stocks and bonds • MovieStocks- represent films, both in the process of being made and that are currently in theaters • StarBonds- represents actors and directors • Anyone can start a portfolio, and when you set up an account you are given two million Hollywood dollars

  15. Hollywood Stock Exchange • When you have an account you can do many things: • Buying – you are betting that the price will rise • Selling – when you think a security has already peaked in its price • Short Selling – when you think a particular security is overvalued and the price is going to go down, you should sell the security “short” • Covering – opposite of short selling, when you realize profit/loss by covering your shorted security

  16. MovieStocks • The price of a MovieStock reflects how much money traders think the film will make domestically in its first four weeks in the box office • For example, if a MovieStock is at H$80, then it is thought it will make 80 million in the first four weeks • Once the opening weekend box office is totaled, a MovieStock will adjust in price to reflect the actual box office gross vs. what was expected • MovieStocks will be cashed out and removed from the HSX four weeks after they have been in wide release

  17. StarBonds • The price of a StarBond reflects the overall star power as determined by HSX traders, how much money their films make at the box office as determined by their trailing average gross (TAG) • When the star’s second film is released the price is readjusted • When a celebrity meets the end of their career, the StarBond is cashed out

  18. Options • These are Hollywood derivatives based around a specific event • “Call” and “Put” options are released on opening weekend of a particular MovieStock • Each option has a “strikeprice” that is set according to what the market expects the film to gross its opening weekend • Options are cashed out on the Monday following the opening weekend at a price equal to the opening weekend box-office gross (in millions) - strikeprice

  19. Extras • Commissions • Insider Trading is LEGAL • Position Limits • Manipulation • Hollywood Reserve Bank • Hollywood Investment Bank (HIB) • Hollywood Securities and Exchange Commission (HSEC)

  20. U.S. Gambling Laws & Prediction Markets • Unlawful Internet Gambling Enforcement Act of 2006 illegalized all online betting • Betfair • IEM has received two no-action letters from the Division of Trading and Markets of the Commodity Futures Trading Commission • HSX not for real profit

  21. Other Popular Websites • Newsfutures – change me • Intrade – www.intrade.com

  22. Accuracy Studies • Dr. Charles Manski • Steven Gjerstad • Real-money vs. n0t-for-profit markets

  23. Sources of Inaccuracy • Can be direct attempts to manipulate the market • 2004 manipulation attempt on presidential markets on Tradesports.com • An anonymous trader sold short so many Bush 2004 presidential contracts that the price was driven to zero, implying a zero percent chance that Bush would win • Attempts like this are short-lived • Ends up increasing the accuracy • Monitors on major prediction market websites

  24. Work Cited

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