Prediction Market
Definition
A Prediction Market (also known as an information market, decision market, or event derivatives) is an exchange where people trade contracts linked to future events. Winning shares pay $1, losing shares pay $0. Prices approximate probabilities.
How It Works
Prediction markets operate on the principle that market prices can reflect the collective wisdom of all participants:
- Market Creation: A clear question with verifiable resolution criteria is defined
- Trading: Participants buy and sell contracts based on their beliefs
- Price Formation: Supply and demand determine prices, which represent implied probabilities
- Resolution: When the event occurs, winning contracts pay out
- Settlement: Winners receive payouts, losers receive nothing
Why Markets Are Accurate
- Incentive Alignment: Participants profit from being correct
- Information Aggregation: Markets incorporate dispersed information from many sources
- Self-Correction: Arbitrageurs correct mispricings
- Continuous Updates: Prices adjust in real-time as new information emerges
Applications
- Political Forecasting: Election outcomes, policy decisions
- Economic Indicators: GDP, unemployment, inflation forecasts
- Corporate Decision-Making: Project timelines, sales forecasts
- Research: Replication markets, scientific predictions
- Entertainment: Awards shows, sports outcomes