Prediction Markets Meet Wall Street

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Corporations, too, are realizing the value of collective intelligence. In 2006 Yahoo! (YHOO) asked employees to dream up new products, but instead of leaving final judgment to top brass, it created a prediction market that let employees bet on which idea would thrive in real-world competition. Microsoft (MSFT) and Google (GOOG) also have tapped the wisdom of employees (BusinessWeek.com, 8/3/06) with similar markets.

Public Health Implications

But now, prediction markets may have even wider applications, bearing relevance to public health and global warming, for example. The IEM is now experimenting with a private flu market that would enable health-care professionals from different states to bet on when flu will erupt in the U.S. and how severe the outbreak will be. Rietz says the flu market may solve a thorny problem for the U.S. Centers for Disease Control, which until now had to watch flu outbreaks in a rearview mirror, too late for hospitals to prepare. "Flu is actually spread in a predictable pattern," Rietz says. "Kids get it first, parents stay home with the kids, and local clinics and nurses see it happening," he explains. "If we can get their information aggregated, hospitals can have an early warning."

Academics now hope to move prediction markets beyond single future predictions to evaluation of many alternative, possible futures. To understand this, think of the basic problem of setting public policy. Will the recently approved $700 billion bailout really unlock credit markets? Or, how about these questions: Would taxing CO2 emissions stop rising sea levels? Which form of energy exploration—oil, coal, wind, solar, nuclear—is most likely to lead to U.S. energy independence? Which Presidential candidate, Barack Obama or McCain, is least likely to start a new war? Each of these questions requires an "if A, then B" prediction.

The idea of scenario forecasts using group intelligence was created by Robin Hanson of George Mason University, who has noted public policy often fails because it is created by an "insider's club of pundits and academics." The trouble with humans, it seems, is that even when we're smart, we have access to imperfect information and follow the groupthink of our peers. Because we often disagree with other groups, we band together and end up agreeing too much with our own teams. No single leader can overcome such biases and data gaps to predict with certainty whether an action will succeed or fail. But Hanson suggests markets can do just that.

Bubbles Aren't New

Certainly all markets have their flaws. Bubbles and busts have been around since the Dutch tulip craze of the 1630s, when single tulip bulbs traded at values 20 times greater than the annual income of most workers. Wall Street's recent mania over questionable mortgages caused today's current crisis, and the manic sell-off backlash was eventually driven by fear, not logic.

But if markets are watched carefully they reveal a vast artificial intelligence, based on the individual data each human provides as he or she makes a best guess about the future. In a way, we are all like bees, frantically collecting pollen and rarely looking up to note the overall hive activity. Occasionally, something like the Dow falling almost 778 points in a single day—or a 936-point rebound a few days later—makes us see the big picture.

Ben Kunz is director of strategic planning at Mediassociates, a media planning and internet strategy firm. He is author of the advertising strategy blog thoughtgadgets.com.