Mercury's Blog

There has recently been quite a bit of discussion on MidasOracle over the value of prediction markets. Part of this was sparked off by the recent Economist article on prediction markets, but part of it has to do with things Chris Masse has been writing for some time now. Chris is very vocal about his views, and I wanted to put a different perspective forward here.

Economist article

A recent article on prediction markets in the Economist was titled “An uncertain future.” I would describe its attitude toward prediction markets as mixed. Here are a few selected quotes:

“But although they have spread beyond early-adopting companies in the technology industry, they have still not become mainstream management tools. Even fervent advocates admit much remains to be done to convince sceptical managers of their value.”

“Koch says the results so far have been pretty accurate compared to actual outcomes, but stresses that markets are complementary to other forecasting techniques, not a substitute for them.”

“Another reason prediction markets flop is that employees cannot see how the results are used, so they lose interest. [...] its most effective trials took place in areas where managers could do something with their findings, making staff feel that trading was worthwhile.”

“Bosses may also be wary of relying on the judgments of non-experts. Yet many pilot projects run so far have shown that junior staff can often be surprisingly good forecasters.”

So I believe the article is generally positive toward the possibility of prediction markets, but generally negative toward the lack of adoption. Which is fair; though I think some good success stories have been kept quiet by some companies for competitive advantage and corporate ego.

Chris Masse’s reaction

Chris Masse has been writing about the prediction market industry for a number of years, and started his blog MidasOracle in about 2006. Strangely, Chris’ writings on prediction markets have become quite negative in recent months. As I understand it, he’s become quite irritated that prediction markets have been touted as “vastly superior” to polls in elections, and other general marketing in the industry. The front page of MidasOracle now has the following statement (his emphasis removed):

The Truth about Prediction Markets

The social utility of the prediction markets is marginal. Number one, the aggregated information has value only for the totally uninformed people (a group that comprises those who overly obsess with prediction markets and have a narrow cultural universe). Number two, the added accuracy (if any) is minute, and, anyway, doesn’t fill up the gap between expectations and omniscience (which is how people judge forecasters). In our view, the social utility of the prediction markets lays in efficiency, not in accuracy. In complicated situations, the prediction markets integrate expectations (informed by facts and expertise) much faster than the mass media do. Their accuracy/efficiency is their uniqueness. It is their velocity that we should put to work.

Remember, dear readers, you heard it here first —on Midas Oracle.

Part of my issue is his definition of “social utility”: namely that I’m not exactly sure what he’s talking about. I completely understand the concept of utility, but “social utility” is a phrase that could mean a variety of things, and I don’t know exactly what Chris means when he writes about it.

My other response to Chris is that I feel he doesn’t distinguish between public and internal prediction markets when he discusses marketing and usage of these markets. I’d like to discuss these issues here.

Public prediction markets

Public prediction markets are tricky things. They’re tricky to get a critical mass of people involved, they’re tricky to get a flow of interesting and valuable contracts, and they’re tricky when events happen that don’t easily conform to how the contracts were established. That said, there are a handful of good and interesting public PM’s. InTrade and Betfair both offer real-money markets, and the better play-money markets include Hubdub, Inkling, Newsfutures, and HSX.

These markets do get press, particularly InTrade in the run-up to the last two presidential elections. InTrade in particular seems to be irritating Chris because of the data point that they forecasted all 50 states correctly. (Which as I’ve written before probably means that the markets weren’t running as efficiently as they could; you’re supposed to get market “failures”.) And I agree with him that too much has been made of this data point.

Overall, I think Chris rightly addresses the issue of the value of public prediction markets. In many cases they’re purely entertainment, and in other cases (even the elections), they’re not necessarily better predictors than other methods. That said, they do incorporate new information faster than any other forecasting model. But I believe Chris wrongly applies these same criticisms to a completely different model, internal prediction markets.

Internal (corporate) prediction markets

Internal prediction markets seek to do either of two things:

• forecast something important to the company where they already have a prediction
• forecast something that’s never been predicted before

When it comes to the first point, forecasting something that the company already forecasts, prediction markets may or may not be an excellent solution. I’ve seen one set of markets that absolutely blew away the accuracy of current forecasts, and I’ve seen other markets that were consistent with current forecasts with little or no accuracy edge. In this case, prediction markets can serve as a fairly low-cost “reality check” on the official forecasts. When they deviate too much, it will raise a flag for investigation. This deviation is particularly helpful since prediction market forecasts are real-time, and can react instantly to new news.

I think the second point above is perhaps the most valuable opportunity. Simple ideas like using a prediction market to establish a RAG status could potentially be very powerful in a company. Depending on the value of the information forecasted, even a moderately accurate prediction market could be incredibly useful to a company.

Chris also over-reacts to some of the marketing from software vendors. Yes, some may mention events like InTrade predicting all 50 states in 2004, but that’s just a party trick to get people interested and in the door. Companies first need to be convinced that the tool works, then they need to be convinced that it works for them. The second part is done individually with their clients so we don’t see it. (Though I really like the case studies that Inkling have put on their website.)

I personally think that he gives too much credit to the popular press in raising the profile of prediction markets; far more credit is due to James Surowiecki and “The Wisdom of Crowds.” (Amazon link)

Summary

Prediction markets are interesting tools, but the lessons learned from public prediction markets are different than those learned from internal prediction markets. It’s important that these two applications are not confused. There will always (and rightly) be questions about the accuracy of prediction markets. In some cases it’s clear that markets are superior, in some internal cases it doesn’t matter since nothing is forecasted right now, and in other cases markets will be about as accurate as what’s already predicted. But in all three cases there is still a valuable argument as to why prediction markets should be used. It all comes down to the specific needs of an industry or company, which is where the vendors step in to help.

The results speak for themselves. Each year there are more software vendors, and each year the existing software vendors hire more people to serve their clients. I’m not going to try and predict the long-term future, but I believe the short-term future is positive.

Quick definition of innovation

First of all, there are multiple definitions of innovation and I want to address this. Here’s a (longer) definition:

Innovation is the economically successful introduction of a new technology or new combination of existing technologies in order to create a stepwise improvement in the value (compared to the resources invested) created for the client.

The problem here is with one word: stepwise. Some people and companies think this must be a massive step; others believe that fairly small step changes can still be considered innovations. In my opinion, this difference in understanding is why the word “innovation” has become the buzzword it has.

Innovation and tools in modern corporations

I’m interested in the intersection between organisational groups and innovation. Specifically, how can new technology help?

In a previous post I discussed the various idea management software packages available to businesses and organisations to help them innovate. But what continues to bother me about all of the software packages I’ve seen is that they seem to pass on responsibility. New ideas and innovations have to go through a process of review, which raises them to increasingly higher levels of management for further review. Employees themselves don’t keep the responsibility for success. They can help forecast and vote for an idea, but that’s it.

Perhaps my military background is showing a bit, but I think much more responsibility can be pushed down to the employees themselves. When I was in the Navy, there were clear rules under which we had to operate. But within those rules, we were very free to experiment and find the best solution for our watchteam/boat/squadron. This extended down to each individual watchstation; even the most junior enlisted man on board had room in which to learn and innovate. (This doesn’t mean that the Navy is an all-innovating organisation; just that there wasn’t needless process and structure for it.)

I personally believe that each additional step of process and each additional rule limits the boundaries of innovation in an organisation. Companies must operate with rules: spending limits are musts, managers must approve formal product introductions, etc. But these are rules for the firm, not for innovation. If you start putting rules and structure around innovation, (such as each project must have a sponsor, projects must have certain approvals before they begin, etc.) a company starts down the slippery slope to irrelevance.

What matters with innovative ideas is that they get implemented. (Or at least implemented enough to “fail fast”.) Does it really matter how if they comply with the main rules in the firm? What matters is results.

Bob Sutton is a very well-known management thinker and professor at Stanford. He writes here:

innovation often happens despite rather than because of senior management, and oddly enough, the best leaders often realize that their very presence can sometimes stifle innovation.

and a fantastic story (confirmed to be true) from HP:

Some years ago, at an HP laboratory in Colorado Springs devoted to oscilloscope technology, one of our bright, energetic engineers, Chuck House, was advised to abandon a display monitor he was developing. Instead he embarked on a vacation to California —stopping along the way to show potential customers a prototype of the monitor. He wanted to find out what they thought, specifically what they wanted the product to do and what its limitations were. Their positive reaction spurred him to continue with the project, even though on his return to Colorado, he found that I, among others, had requested it be discontinued. He persuaded his R&D manager to rush the monitor into production, and as it turned out, HP sold more than 17,000 display monitors representing sales revenue of $35 million for the company.

What to do?

Fundamentally, there is a difference between coming up with the ideas and innovations and formally developing them. At what point do you make what’s really an entrepreneurial-type activity a big-company project management process? Do you do it while it’s still just an idea, or later in its life? I know where I personally come down on this question… what about you?

Future prediction markets news

I’ve been working with a media company in London to develop a public prediction market for their (industry vertical) network. It’s still softly launching, and I don’t want to steal any thunder until they’ve had a chance to fully promote it. But I look forward to discussing it in the future here.

One last note…

As I mentioned before, this blog recently achieved a Google PageRank of 6/10. Because of this I’ve been getting a LOT more spam in the comments, and have made the comments section completely moderated. But please comment below; I will approve it (hopefully) shortly thereafter.

Happy New Year to everyone! I hope that 2009 is happy, healthy and prosperous for you. I specifically wanted to thank you as a reader of this blog, and those who have linked to my posts here. Google recently refreshed their PageRank for Mercury’s Blog, and it now has a PageRank of 6/10! Though I don’t post often, I do try to write long-form news and analysis, and I’m glad you’ve found it useful.

What I expect for prediction markets in 2009

I’m probably going to regret doing this by the end of the year, but I’m going to put on my forecasting hat and try to predict what will happen this year in the field of prediction markets.

• Prediction markets in 2009 are going to become even more well-known and wide-spread, but there will be no single event that brings them to the attention of the public. It’s going to be a slow, but steady, growth.
• All of the prediction market vendors will mature their business offering/proposition. Both InklingMarkets and Xpree have made recent business development hires, and Inkling recently redesigned their website with a stronger business pitch and case studies. I think that business cases for prediction markets will be more clear and more developed in general because of this.
• HubDub will continue to only be the only strongly popular play-money prediction market. (HSX is probably similarly popular, but is a single-industry prediction market.) With Hubdub’s partner program and social networking features, they will see significant growth this year.
• While a couple additional software vendors may appear, I get the feeling that the market for prediction market software is largely saturated. People working on projects part-time and selling them may proliferate and be suitable for the lower end of the market, I don’t see many more serious prediction market software companies starting up in 2009.
• I’m looking forward to see how the CantorExchange develops. Will there be enough customers? Will the market see the effects of other studios trying to bid the prices of their competitors’ films down? Or will it be seen more as a financial hedging tool for institutions involved in the film industry? There are lots of open questions to evaluate here, but I still maintain it’s a great step forward for the prediction markets industry.

What to expect from this blog in 2009

I’m going to continue posting on both prediction markets, but continue talking more and more about how collective intelligence can be used in other contexts. Specifically, I’ve become really interested in how groups of people develop new ideas and new innovations.

As I’ve written before, I really don’t like the word “innovation.” Bruce Nussbaum at BusinessWeek has written a few things lately that I really like:

“Innovation” died in 2008, killed off by overuse, misuse, narrowness, incrementalism and failure to evolve. It was done in by CEOs, consultants, marketeers, advertisers and business journalists who degraded and devalued the idea by conflating it with change, technology, design, globalization, trendiness, and anything “new.” It was done it by an obsession with measurement, metrics and math and a demand for predictability in an unpredictable world.

and

“Innovation” is inadequate as a concept to deal with these changes. You have “game-changing” innovation, which is big but rare and incremental innovation which is small but common.

The truth about innovation is that it takes groups of people a lot of work to find and develop new ideas and turn them into innovations. Scott Berkun has a great chapter in his book “The Myths of Innovation” where he destroys the myth of the lone creative genius.

We know it takes groups of people to make innovation happen, so where are the tools for it? A lot of time, money and effort has gone into social networking software to connect people, such as Facebook, MySpace, etc. But I have to agree with Tim O’Reilly: we need to stop throwing sheep and do something worthy. But those tools can be very useful to us in helping foster innovation. I reviewed the software for idea and innovation software recently, but was left generally unimpressed.

These are some of my current thoughts. I plan on thinking out loud more in 2009 on these topics and seeing where it takes me. I look forward to your feedback.

Are you a successful trader on the Hollywood Stock Exchange (aka HSX)?

Well, now you could potentially turn that expertise into cold, hard cash. Cantor Fitzgerald, the company that owns HSX, has announced a real-money equivalent, the Cantor Exchange. On it you’ll be able to trade “Movie Box Office Contracts.”

It was officially announced Monday, December 8th through press releases on the new CantorExchange website. To quote from the press releases:

Cantor Fitzgerald, L.P., a leading global financial services firm, announced today that it has filed an application with the Commodity Futures Trading Commission (“CFTC”) to launch the Cantor Exchange. Cantor Exchange intends to list Domestic Box Office Receipt contracts as the exchange’s first traded product.

[...]

Subject to final regulatory approval of the Cantor Exchange application, Domestic Box Office Receipt contracts will offer film finance professionals and traders a new opportunity to hedge and speculate on the theatrical performance (ticket sales) of major film titles. Domestic Box Office Receipt contracts will be a next generation financial management tool that allows film professionals to hedge risk and provides speculative opportunities to other market participants based on the first four weeks of a film’s box office performance.

The first Domestic Box Office Receipt contract is expected to be listed on the Cantor Exchange in the first quarter of 2009, subject to final approval of the Cantor Exchange application by the CFTC.

If you’re willing to sit through the video’s cheesy music on the site, you’ll find out that traders can get started with $50 in their account. It appears they’re pitching the buy-side (generally) for fans looking to share in the up-side and pitching the sell-side (generally) for investors and others looking to hedge their investment.

Each contract starts with a week-long auction to determine the starting price. Every 24 hours the exchange will publish the overall market price that would be achieved based on all the buy and sell orders entered. Before going to continuous trading, all buy/sell orders will be cleared at the single best market price.

Summary

I think this is great news, as it starts to push the boundaries of acceptance of futures (aka “prediction”) markets. I wish Alex and the rest of the team there all the best luck in the approval process and look forward to trading a bit there myself!

It should be interesting to hear what the mainstream press thinks of this development.

So a number of interesting things have come across my desk recently, all of which I wanted to write about but none of which really became its own post.

Askmarkets.com has launched!

George Tziralis‘s new project, Askmarkets, has now officially launched. George has been beta-testing it for a while, so it’s great to see it officially go live.

The most unique thing about Askmarkets to me is that it uses David Pennock’s DPM (Dynamic Pari-Mutuel Market) as an automatic market-maker instead of Robin Hanson’s MSR (Market Scoring Rule). It largely operates the same way, though with a DPM the person/company running the market isn’t required to subsidize the market-maker losses. (This theoretically makes it more attractive for eventual real-money applications.)

Nostradamical.com has launched

This is a new prediction market site that I heard about recently. It seems like a decent site, and I really like that it was developed by just one guy (Brad Young) here in the UK! While you can show your confidence in a particular outcome through a slider, I don’t like that I can’t adjust how much I “bet” on a given outcome. While I might be very confident about something in my industry, I wouldn’t want to bet the same amount on a pop culture topic. (I’m likely the last to know any Britney Spears news.)

Good luck to Brad as he improves and expands the site!

CFTC new scope?

The CFTC may be gaining a much broader new scope. If Senator Harkin passes his bill, it “would force all over-the-counter derivatives, including credit-default swaps, onto regulated futures exchanges.” This would be overseen by the CFTC.

To quote some interesting lines from the Wall Street Journal article:

[...]those financial contracts would be standardized and centrally cleared. It would also mean that they could be subject to CFTC-imposed speculative position limits and federal reporting requirements.

Under current federal law, certain financial derivatives are excluded from the definition of a commodity. The law, which was amended in 2000, created distinctions between what are known as “exempt” and “excluded” commodities.

The CFTC has no regulatory authority over excluded commodities, which include credit-default swaps. Transactions involving exempt commodities, such as metals and energy, may not fall under some of the CFTC’s rules and regulations if those contracts meet certain requirements.

Sen. Harkin’s new bill, dubbed the Derivatives Trading Integrity Act, would eliminate the distinctions in the law between excluded and exempt commodities, treating them all the same.

Hedging versus Gambling

Speaking of the CFTC, I was talking with some people recently about how to define the difference (in more layman’s terms) between hedging and gambling. The central question was: is there an inherent risk?

The classic case is that of farmers having a risk of their crop prices changing dramatically during the growing & selling seasons. The Chicago Board of Trade helped farmers hedge their inherent risk of significant market changes between the time they planted their crops and when those crops could be sold.

That can be contrasted to sports, which are typically understood as gambling. While some individuals may have emotional risk tied up in a teams’ win or loss, there is no inherent risk… sports are entertainment first and economic enterprises second.

In the middle, however, are contracts on something like the US Presidential election. A change in government ripples across the economy, and so businesses and individuals may very well have some risk in various election outcomes.

So while the question “is there an inherent risk?” helps to clarify some situations, there is still a spectrum of answers. While this may be second nature to some or many readers, I think it’s a better question to help separate hedging from gambling in many novice/lay-person’s minds.

Google Prediction Markets case at HBS

Andrew McAfee is a professor at Harvard Business School who does a lot of work, research and teaching on “Enterprise 2.0″. He has worked with/talked to Bo Cowgill at Google and has written a case study on Google’s prediction markets.

He’s also a twitter user and I wanted to quote one of his “tweets” here:

Google prediction markets case teaches like a dream – http://snurl.com/5q78q

I personally think this is a really good, solid step towards recognizing prediction markets as a valid and valuable internal tool. Hopefully more and more people will come into business knowing that prediction markets exist and that they can provide valuable information to managers about what their company is doing.

My HubDub post-election market

Finally, I put up my own post-election market on HubDub, on US Supreme Court justices. Please check it out below and trade!

How many US Supreme Court Justices will retire by the end of 2009?