Mercury’s Blog

If you're new here, you may want to get Mercury's Blog by Email or subscribe to my RSS feed. Thanks for visiting!

Companies are rightly concerned about getting good results from prediction markets. In particular, some important and strategic decisions have a very limited group of employees that know enough to trade in a prediction market. This is sometimes because the company is small and there aren’t that many employees in the first place, but often the specific issue at risk requires so much background and experience that participation by a wide group is implausible.

For example, product manufacturers keep track of sales of their products and are keenly interested in predicting future sales. However, the data is key to their operations and closely held within the company. Only a small group of people (often in Finance, or top Operations personnel) have access to past and current sales figures, and thus have the requisite background information to forecast future sales. This could be seen as a hopeless situation.

That scenario is in fact far from hopeless. Our pre-conceived notions of an efficient market typically involve screaming traders in a pit of chaos. Many people believe that it takes a large group of traders to get good quality predictions. It turns out that markets can also work on a very small scale. This issue was the focus of the first research project completed by Mercury Research and Consulting. (Find the paper on our website; selected for publication in the Journal of Prediction Markets.) The question we asked was: how low can you go?

As it turns out, pretty low. Our research showed that as long as just 15 traders participate in a market, the results are well-calibrated. This is an important finding because it helps to answer two questions:

* Can a prediction market accurately answer this question?
- and -
* Do I need to alter incentives in order to ensure a sufficient number of traders?

You will likely find that in most situations you can get the fifteen or more traders necessary to make an efficient market, though it may require some creativity in diversity of participants. However, you may need extra incentives in order to get them to trade. For example, if there are only 20 people that can reasonably participate in a given market, different tactics may be required to ensure that most of them participate. (Larger prizes, more significant internal recognition, etc.) If less than fifteen people can address a given area of risk, it may be suitable to find alternate means of forecasting than a direct marketplace scenario.

So does your company need to stick to “safe” topics on which anyone and everyone in the organisation has an opinion? Not at all! Specialist questions on key risk areas can be just as accurate with just a small number of participants, as low as fifteen. The fewer the number of people involved, the more important it is that they are independent of each other, but they are still fully able to accurately predict an outcome.