July 20, 2005 · Cass Sunstein
Prediction markets, springing up at a rapid rate, provide another way of aggregating private information. Far more Hayekian than simply polling people, these markets have had some terrific success in predicting the outcomes of presidential elections (see the Iowa Electronic Markets) and also in predicting the Oscars and general box office results (see the Hollywood Stock Exchange). For Hayek’s reasons, it’s easy to see why prediction markets might work well. They aggregate private judgments, and dispersed bits of information, in a way that is backed by economic incentives. They have big advantages over the Condorcet method (poll and average) and what we might call the Habermasian method (deliberate and exchange reasons).
Here’s the but: The prediction markets apparently did very badly with the Supreme Court nomination. Roberts was way behind for a long time on tradesports.com, and during the Clement cascade, Clement started to dominate everyone else. (Also Rehnquist was strongly predicted to resign; investors got that one wrong too.) Can we develop a general account of when prediction markets will work well, and when they won’t? (And if so, should we eventually test that account in a prediction market?)