Weird Science

Today's little post is about something I've been really interested in for a while now, and decided its time to share this interesting combination of human behavior, collectivism, and the stock market. They're called prediction markets:

Prediction markets are speculative markets created for the purpose of making predictions. Assets are created whose final cash value is tied to a particular event (e.g., will the next US president be a Republican) or parameter (e.g., total sales next quarter). The current market prices can then be interpreted as predictions of the probability of the event or the expected value of the parameter. Other names for prediction markets include information markets, decision markets, idea futures, event derivatives, and virtual markets. (Wikipedia)

Okay interesting right? Trading stocks in future events. But here's the thing, the little fuckers are painfully accurate. Ever watch a school of fish? Notive how at a given time many of them are darting in different directions. But once in a while enough of them will dart them same direction until that hit some behavioral critical mass and the entire group will turn. Computers are very good at distributed processing, but here we have evidence that organic behavior can use that same principal. A little more from Popular Science:

The first and most famous prediction market, established at the University of Iowa business school in 1988, was designed to forecast the outcome of that year's presidential election—which it did, with remarkable precision. Anyone could join the market and buy or sell propositions such as "What percent of the popular vote will George H.W. Bush receive in the presidential election?" Traders who thought Bush would get 60 percent or more of the vote would buy the shares if they were less than $60. Traders who disagreed would sell. The market price reflected the consensus view, which turned out to be more accurate than any of the six polls released in the week before the election. But if predicting a landslide Bush I victory over Michael Dukakis seems like fish-in-a-barrel stuff, consider that the Iowa Electronic Markets have correctly predicted the winner of the popular vote in every national election since then, and with greater accuracy than the Gallup poll in all but one of those years. It achieved this success by relying not on the oracle-like knowledge of a single "expert" or small group of pundits, but on the power of the market to efficiently gather the intelligence of traders and agglomerate them into collective wisdom.

So much for the "great unwashed." I've been reflecting a lot on this concept lately and considering what it means for us as social creatures and, in the micro, our own individual behavior and how that's effected by larger systems. If you'd like to read a little more on this phenonmemon, including more examples of its accuracy surf over to Popular Science's website. They've got their own predictions market, the PPX, and a great article about the science behind it (link).