Prediction Markets: Should You Be Skeptical of Them?
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We're here because your heightened awareness deserves heightened entertainment. The Last Show with David Cooper prediction markets. They claim to forecast the future, investing based on elections, recessions, even who will win an Olympic gold. But is getting involved with them a genius investment or is it just betting dressed up a little different? I'm here with someone who's run these markets. He's researched them. And the question is, should we be skeptical of them? I'm here with Werner Antweiler, an economics professor at UBC's Sauter School of Business. Werner, welcome to the show. Hello, David.
What are prediction markets and how do they work?
Thank you for having me on your program. It sounds fancy. It doesn't sound like going to a casino, a prediction market. Sounds like something that a reasonable person would invest in. What are they? If I was at a dinner party with you and I'd never heard of them, how would you explain them?
Yeah, it's essentially like any other futures market where you can buy and sell shares in a contract. And the basic idea is that you're predicting events in the future by trading on the outcome of a particular event, like an election or the invention of a new drug potentially, but mostly it's sports events.
Are prediction markets just a fancy form of betting?
And so in that sense, it's very similar to betting.
So it's not dissimilar than sitting in that sports room in the casino, placing a bet on the football game in the screen. It's just a sort of fancy dressed up way of doing that.
Yeah, the main difference is that you can trade it continuously. So before the event happens, you can actually go and sell your shares or buy new shares. And the information that you have about the event reflects the prices. So it's basically different than placing a bet because you can still change your position any time until the event happens.
So you ran one, a not-for-profit, I imagine, sort of research sort of prediction market. For how long did you run one?
Yeah, we ran it for about 20 years. We ran prediction markets for elections in British Columbia and at the federal level in Canada. And we wanted to find out how these prediction markets work and what is actually working well, what is not working well. The basic appeal of these markets is that it's crowdsourcing information different from public opinion polls. It's really asking people to put... their money where their mouth is. It's basically harnessing the wisdom of the crowds by aggregating all that wonderful information when people aren't just asked about, now, what do you think is going to happen, but where they really have to put money into their beliefs. And that is the appeal of these markets.
Well, the wisdom of the crowd. When I think of a crowd, I think mob mentality. I don't necessarily think wisdom. What are some of the surprising ways in which people behaved when they had access to this financial instrument, I guess you call it?
Yeah, so actually we ran different types of markets. One was very much like a futures market where we were trading in the outcome for predicting the seed share in the House of Commons. And that is a continuous number. But people are attracted to these what we call binary option contracts, an all or nothing contract where you either win or you lose. And so basically, like the majority government who forms the next government. And people are much more attracted to these leveraged markets than to the markets that trade in continuous outcomes. The appeal then is like now you invest maybe $30, $40, and you get $100 in return if you actually win the big prize, which is the outcome comes true that you're predicting.
What are the advantages of using prediction markets for forecasting?
Like, you know, say one party forms the next government. So this attraction to these really leveraged options is also part of the problem. It really looks in the end like gambling because you're not really trading in this continuous outcome like a commodity price for oil or gas or something like that, but you're trading in this very leveraged position. You either win all or you lose everything.
There are those, and I'm not one of them, I'm not a fan of these actually, but there are those that would say trading stocks is gambling as well.
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