1. What are prediction markets?
2. Why believe prediction markets are accurate?
3. Why believe prediction markets are canonical?
4. What are the most common objections to prediction markets?
5. What are some clever uses for prediction markets?
6. What’s the current status of prediction markets?
7. What can I do to help promote prediction markets?
1. What are prediction markets?
Prediction markets are like stock markets, but for beliefs about future events. For example, you can buy or sell shares in events like “The Democrats will win the next election” or “A Category 5 hurricane will hit Florida this year”.
Typically, a share pays out $1 if the event occurs, and nothing if it doesn’t. In this scenario, the price of the share will naturally represent the market’s belief about the likelihood of the event. For example, if a share in “The Democrats will win the next election” trades for $0.20, then the market believes there’s a 20% chance the Democrats will win the next election.
Why does this work? If it didn’t, you could make easy money. Suppose that a share in “The sun will rise tomorrow” was priced at $0.20, even though there’s a 100% chance that will happen. You could spend all your money on shares, and then, when the sun inevitably rose and the shares paid out $1, you would quintuple your money. If you think about different situations, you’ll realize that the only time you neither want to buy nor sell is when you think the share’s price correctly represents the probability.
Prediction markets have two good qualities: in ideal situations, they are accurate and canonical.
By accurate, I mean that that over the long run, they will be at least as accurate as any other source of information.
By canonical, I mean that they short-circuit discussion of “which expert should we trust?” or “how do we know which sources are biased?” All prediction markets speak with a single unified voice, that voice will always be at least as trustworthy as any individual expert, and it cannot be biased. If you’re not sure which of many competing experts (or supposed experts) to trust, you should always trust a prediction market instead of any of them. And the same is true of people on the opposite side of the political spectrum who doubt all the sources you trust and vice versa.
According to Pew Research , a poll of experts named “the breakdown of trusted information sources” as one of the leading challenges of the 21st century (who are these “experts”? was the poll fair? did Pew really say this, or am I making it up?) Millions of words have been written on how to solve this crisis, with most ideas being impossibly naive or dangerously authoritarian. I think prediction markets are a genuine solution, one that can’t come fast enough.
The rest of this FAQ tries to expand on these ideas, justify these surprising claims, answer some common objections, and explain where the prediction market industry is right now. It will start by presenting the theoretical argument for why prediction markets should work, then go into some reasons why they might work less well in real life, then try to bound how much damage the real-life problems can cause.
Because prediction markets work a lot like other markets (eg the stock market), some of this FAQ will be too basic and obvious for people who already have a good understanding of finance. You can skip these parts once you notice them.
Prediction markets are like stock markets, but for beliefs about future events. For example, you can buy or sell shares in events like “The Democrats will win the next election” or “A Category 5 hurricane will hit Florida this year”.
Typically, a share pays out $1 if the event occurs, and nothing if it doesn’t. In this scenario, the price of the share will naturally represent the market’s belief about the likelihood of the event. For example, if a share in “The Democrats will win the next election” trades for $0.20, then the market believes there’s a 20% chance the Democrats will win the next election.
Why does this work? If it didn’t, you could make easy money. Suppose that a share in “The sun will rise tomorrow” was priced at $0.20, even though there’s a 100% chance that will happen. You could spend all your money on shares, and then, when the sun inevitably rose and the shares paid out $1, you would quintuple your money. If you think about different situations, you’ll realize that the only time you neither want to buy nor sell is when you think the share’s price correctly represents the probability.
Prediction markets have two good qualities: in ideal situations, they are accurate and canonical.
By accurate, I mean that that over the long run, they will be at least as accurate as any other source of information.
By canonical, I mean that they short-circuit discussion of “which expert should we trust?” or “how do we know which sources are biased?” All prediction markets speak with a single unified voice, that voice will always be at least as trustworthy as any individual expert, and it cannot be biased. If you’re not sure which of many competing experts (or supposed experts) to trust, you should always trust a prediction market instead of any of them. And the same is true of people on the opposite side of the political spectrum who doubt all the sources you trust and vice versa.
According to Pew Research , a poll of experts named “the breakdown of trusted information sources” as one of the leading challenges of the 21st century (who are these “experts”? was the poll fair? did Pew really say this, or am I making it up?) Millions of words have been written on how to solve this crisis, with most ideas being impossibly naive or dangerously authoritarian. I think prediction markets are a genuine solution, one that can’t come fast enough.
The rest of this FAQ tries to expand on these ideas, justify these surprising claims, answer some common objections, and explain where the prediction market industry is right now. It will start by presenting the theoretical argument for why prediction markets should work, then go into some reasons why they might work less well in real life, then try to bound how much damage the real-life problems can cause.
Because prediction markets work a lot like other markets (eg the stock market), some of this FAQ will be too basic and obvious for people who already have a good understanding of finance. You can skip these parts once you notice them.
by Scott Alexander, Astral Codex Ten | Read more:
[ed. See also: The Buying Things From A Store FAQ (skip to 10); and, Self-Serving Bias (ACT).]
