July 22, 2005 · Cass Sunstein
First things first: A grateful thanks for the incredibly helpful comments on my ignorant queries about OSS. (More comments on those queries are more than welcome.) The comments prompt the following thought. For OSS, there’s a lot of dispersed knowledge and also creativity, and that’s a big reason for the success. Something similar is true of Wikipedia (though as some people have suggested, the aggregation process is less reliable there). With ordinary product markets, there’s also a lot of dispersed knowledge, both about product performance and about individual tastes. If a watch doesn’t keep time very well, the market will respond, at least in the aggregate. If most people like the looks of a new car, the market will respond too.
Here we have a clue about why prediction markets sometimes fail, as in the cases of the Rehnquist resignation and the Roberts nomination. There just isn’t a lot of dispersed information out there about what the Chief Justice is likely to do or about the President’s particular choice. It follows that we shouldn’t think (as many do) that prediction markets will be able to foresee terrorist attacks. Investors, taken as a whole, probably lack the information that would make for judgments that improve on the conventional wisdom. If this is right, then prediction markets are unlikely to do well in foreseeing a range of international events.
I have a feeling that this is just a rough cut at the question — and some of the comments to an earlier post might do better — but maybe we’re making some progress.