![\"skin](\"https:\/\/weknow0.co.uk\/wp-content\/uploads\/2013\/06\/skin-in-the-game.jpg\")
<\/a>In my previous post, I looked at some of the reasons why we are so useless at making economic predictions, and some of the ideas for what might be done about it. One of the key problems, raised by Nassim Nicholas Taleb most recently in his book Antifragile<\/em>, is the absence of skin in the game, ie forecasters having something to lose if their forecasts are wildly off.<\/p>\nBut what if all forecasters had to have something to lose before they were allowed to make forecasts? What if every IMF or OBR forecast came with a bill if it was seriously adrift? What if you knew whenever you read a forecast in a newspaper or on a television screen that the person making that forecast had invested something in their belief in their own forecast?<\/p>\n
Betting on events dates back at least to the 16th<\/sup> century, but prediction markets (also known as predictive markets<\/span>, information markets, decision markets<\/span>, idea futures<\/span>, event derivatives<\/span>, or virtual markets) <\/span>have developed most strongly over the last 25 years or so (the University of Iowa<\/a> launched its first electronic market as an experiment in 1988). Intrade<\/a>, which describes itself as the world\u2019s leading prediction market, is now a little smaller than it was following the news just before Christmas last year that it would no longer let Americans trade on its site. It had been sued by the US regulator of the commodities derivative markets for breaking a commitment not to allow trading on the constituents of those markets.<\/p>\n A paper on prediction markets earlier this year called Prediction Markets for Economic Forecasting<\/a> by Snowberg, Wolfers and Zitzewitz suggests there are 3 main types:<\/p>\n \u00b7\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 <\/span><\/span><\/span>Winner takes all<\/b>. If the event you have bet on happens you win. If not, you lose your stake. Intrade is this type of prediction market: you pay a proportion of \u00a310 a share based on the average probability of the event happening (according to the market participants) and get \u00a310 back if it happens, nothing if it doesn\u2019t. The Iowa Electronic Market current offerings, on congressional elections and US federal monetary policy, are also winner takes all. The price of the bet at any time should reflect the market\u2019s view of the probability of the event happening.<\/p>\n \u00b7\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 <\/span><\/span><\/span>Index<\/b>. The amount paid out is unknown but tied to the variable you are betting on, eg the number of seats won by a party in a particular parliamentary election, or the value of an index at close of business on a particular date. The price of the bet at any time should reflect the market\u2019s view of the expected value of the outcome.<\/p>\n \u00b7\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 <\/span><\/span><\/span>Spread betting<\/b>. Most commonly found on sports betting sites, the amount bet and the amount paid out are fixed, but the event that leads to a pay out (eg number of goals scored in a match more than x) changes until the numbers of buys and sells match (a \u201cbuy\u201d in this example is betting the number of goals will be above x, a \u201csell\u201d is betting the number of goals will be below y, a number less than x. The spread, on which the betting site makes its money, is the difference between x and y. This could equally be applied to the values of an index at a particular date (eg Spreadex<\/a> offer just such bets on several major share indices as well as currency exchange rates). Depending on the relationship between the pay out and the bet, the value of the spread points at any time should reflect the market\u2019s view of a particular point in the probability distribution of the event, eg if the pay out is twice the bet, this would be the median (ie a 50% chance of the outcome being higher or lower).<\/p>\n