Back to the Future

While my first contract job here in the big city is coming to a close, I’m starting to think back to my own project I had been working on. I became interested in prediction markets last fall so I read up and studied as much as I could about them. The idea of predicting the future by using a market with contracts based on some future event is really cool. I joined up a few of the big sites and played around a bit. Then I had a thought. Why is there not more interest in these markets? One conclusion I came to was that the mechanics of a market are not something the average person is familiar or comfortable with. Also, my own interest in the markets waned because the lack of participation caused lulls in the action.

So I started working on how I could improve the prediction market to draw more interest. The conclusion I came to was a model where the contracts could not only be presented by a market mechanism, but also by a simpler betting model, the parimutuel betting pool. This is a mechanism used in horse races which is familiar to those who bet on sports. Presenting the prediction in a parimutuel form would cater to different bettors who do not want to use a market interface. In a nutshell, the bettor (investor) would place a bet amount on a particular choice. Once a winner is chosen, the money pool is distributed to the winning bettors proportional to their bet amounts.

Then I realized this could be taken one step further. The contracts could also be used with a poll, or lottery, mechanism. In this form, each participant would ante up a predetermined amount and select their guess. The pot would then be distributed in some fashion amongst the winning guesses, usually by giving the entire amount to a random participant. This big win amount should stir up interest by those who don’t wish to use the more complex interface outlined above.

Finally, these 3 methods are linked together by calculating the probability of a particular outcome based on participation. The probability of a market contract would be inherent in the price of that contract. The probability of a parimutuel choice would be the amount of money bet on that choice divided by total money bet on all choices. The probability of the poll, or lottery, would be the number of guesses on a particular choice divided by the total number of guesses. With these 3 probabilities available, it is easy to aggregate the 3 methods into one information pool which will track the current probability of all the possible outcomes of an event. There are some hurdles, such as the need to allow the poll/lottery model to incorporate new information about the event. This can be done by allowing a participant to withdraw their choice and guess a different one.

I feel that this presentation model could allow for much greater interest and participation, which would provide greater accuracy in probability of events, which in turn is more valuable to those who are relying on such statistics. I hope to take this idea to completion and create the software necessary to provide this interface.