Prediction Markets for the stock market? Huh?
July 2nd, 2007If you're new here, you may want to get Mercury's Blog by Email or subscribe to my RSS feed. Thanks for visiting!
I was recently e-mailed about a new website that was billing itself as a new prediction market. It’s called “MainStreetWisdom,” and was apparently developed by some investment advisors in Dayton, OH. Here is a small quote from what their e-mail:
However, under certain conditions - when a group loses its diversity and independence - a wise crowd can turn mad. The stock market is usually made up of a group of diverse and independent actors and does a good job of pricing securities most of the time. However, there are times when the market or pockets of the market loses its diversity and independence and prices become irrational.
This kind of thing irritates me, and is bad for the prediction market industry. Sure, prediction markets could be used to predict stock prices, but why? There are a number of financial instruments already out there that do this exact thing. Perhaps more worrying is that the firm that developed this website could actually use this site to guide their own investment decisions. Yikes! True, the stock market isn’t necessarily an “efficient market” but there’s no way 30 guys in Ohio are going to consistently beat it by doing this.
The Inkling guys developed a similar website late last year called Worthio. (It appears to have now gone dark.) This was less a prediction market for the stock market than it was a community site around the stock market. It had a Digg-like interface to vote on if you were bullish or bearish about a stock, discussions for each company, etc. I was never particularly clear on how it would be useful, even if there was a lot of traders and information being shared.
Contrast this to what HedgeStreet has recently announced: prediction markets on earnings forecasts. Any trader can go to HedgeStreet and try to profit from their own analysis of eleven of the market’s bigger companies to predict quarterly earnings. I think this is a great application for a prediction market. Currently, earnings forecasts are generated by various analysts at the various investment banks, and published/discussed in the run-up to the target company actually publishing the results. These analysts develop the “Wall Street consensus” that is discussed in the newspapers.
By developing a prediction market for these key metrics, HedgeStreet allows traders to get in on the action by letting them profit on their own analysis. Currently there is no aggregation mechanism for the various independent analysts; HedgeStreet now provides it and a profit opportunity.
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Prediction markets are market tools that can be used to predict key strategic data. They are not tools to predict what markets are going to do. Sites like the one discussed above confuse the issue for those that aren’t experienced enough to understand the difference.
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