Prediction market

A prediction market is a speculative market in which participants trade contracts whose payoff depends on the outcome of future events. The market price of a contract aggregating these bets becomes a probability estimate — a wisdom of the crowd mechanism in which traders with private information are incentivized to reveal it through their wagers. Prediction markets have been shown to outperform polls, expert panels, and statistical models in forecasting elections, box office returns, scientific replication, and geopolitical events.

The theoretical foundation is information economics: when traders possess diverse private information and can profit from trading on it, the market price converges to a weighted aggregate of all available information. This aggregation works only when the market is sufficiently liquid, traders are properly incentivized, and no single participant can manipulate the price. The design of prediction markets — whether to use continuous double auctions, automated market makers, or scoring rules — is a problem of mechanism design.

Prediction markets also illuminate the conditions under which collective intelligence succeeds and fails. Markets fail when information is concentrated among participants who cannot trade (due to insider trading restrictions or classified access), when the event is unprecedented (no participant has relevant private information), or when traders herd rather than bet independently. The 2008 financial crisis demonstrated that a market of sophisticated participants using correlated models can produce collective mispricing rather than collective wisdom.