HW4

HW due Wednesday 9/22/10

Prediction Markets: Tapping the Wisdom of Groups


Recall that prediction markets try to combine peoples' best judgments using a financial incentive to make sure the judgments really are the best they can make. There is interest in this topic - for example an academic journal started in 2007 which is devoted to scholarly examination of prediction markets, their structure, how well they work, etc.

This HW will hopefully be fun, and will help you gain a hands-on understanding of how prediction markets work.

1) (22.5 pts.) Let's assume you have $1,000 to invest in prediction markets. Naturally, you want to make more money, meaning that when you sell your best judgments you get more than the $1,000 you invested. Identify a prediction market company that you want to pretend invest in. We looked at http://www.intrade.com/ in class but it is easy to find others: just do a Web search on "prediction market." Using intrade as an example, http://www.intrade.com/ has both a set of real markets where you can invest (or some might claim gamble) real money, and a practice market site where you can invest pretend money. You can pretend invest in the real market without signing up for a login, or you can make a login account with them and use the practice market. Or you can find another prediction market other than intrade.com. You could even sign up for real at some prediction market company (keeping in mind that this course does not endorse, or suggest you to spend real money on, any particular company!). For the next question let's assume you are making pretend use of intrade's set of real markets.

2) (22.5 pts.) Find 10 prediction markets that you are interested in or know more about than most others. For example, you might pick the prediction market for whether 2010 will be the hottest year on record, the prediction market for some election issue that you might have some familiarity with, and some other eight. In fact there are dozens and dozens if not hundreds of markets they have easily accessible from their Web site. Make a list of your favorite 10.

3) (22.5 pts) For each of the 10 markets, decide whether the current probability shown on the graph is higher or lower than your best judgment. For this assignment it is the most recent number in the graph that we are interested in. List which of the 10 you judge the current probability to be too low. For example, maybe the graph shows 66 but you think 85% would be more accurate. Those are the ones that you expect to go up, so that you could make money.

4) Invest your $1,000 in the ones you feel are currently too low, as follows.

• a. (3.5 pts.) Pick one of the markets. Say which one
• b. (3.5 pts.) Figure out the price of a single contract (a contract is a little like a share of stock). That price is: (the probability in percentage points) x ($0.10). So if the probability on the graph is 65, meaning 65%=0.65, then a single contract will cost you 65 x $0.10, or $6.50, to buy. Give this price in your HW.
• c. (3.5 pts.) Decide how many contracts to buy (remember you have $1,000 but will want to spread that over a number of different markets). Note the number in your HW.
• d. (3.5 pts.) Figure out the total amount you are investing in this market. State this.
• e. (8.5 pts.) Subtract that from $1,000 to find out how much you have left to invest in the other markets. Then go through the above steps again using another market. Repeat until you have invested all of the $1,000 in the markets you have chosen to invest in.

Please note that if you think a graph shows a number that is too high, then it would make little sense to buy shares of that market since you think it will eventually go down!

5) (10 pts., to be assigned toward the end of the semester. 10 if you make money, but only 5 if you lose money, sorry!) You may sell any of your contracts at any time during the semester, and buy any new contracts you like with the money you got from selling (or just hang on to the money if you prefer). You are not required to do this, if you just want to keep the same contracts. To sell, just see what the contracts you have are worth, using the graphs at the company Web site, and pretend you've sold them. Keep track of what you do by editing your blog entry for this HW. Toward the end of the semester I will ask everyone to sell everything and we'll see how much money you've made or lost!


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A note about the next HW: the following or something like it will be part of the next HW, but not this one.

Recall that a project is part of the course, and this project will grow step by step throughout the semester. In other words, you will keep adding to it as we go along, so that in the end it will be a piece of work you can be proud of! Make up a tentative plan for your term project, which will be a paper, software system, combination, skit or musical performance or painting (if you are a fine arts major), or whatever it is. You may analyze the same topic as you used for your Delphi exercise, or change topics but include the Delphi results as an appendix or supplemental report. Also, answer the question, "What would be a good thing to do next on this project?"