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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.

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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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