Prediction Markets / Mike Robb / 14 February 2008 / Leave a comment

Mike Robb takes us through the ins-and-outs of what a prediction market or prediction exchange is, why it's useful and what you should look out for...

A prediction market (housed in prediction exchanges, such as Betfair) is any market whereby predictions are formed by two sets of people trading against each other with real money at a certain price, with the percentage chance of a certain selection winning changing as more money is traded at the given price.

Betfair has over 400,000 people actively trading against each other while the Betfair exchange handles more than five million bets (that's five million bets every day - more than the all the European stock markets combined!). With that many people betting that much money, Betfair is undoubtedly the number one source of prediction out there.

Every market offered on Betfair is essentially a prediction market. In the basic sense of the term, it is any market from which a prediction can be drawn. Thus, if Manchester United are [1.3] to beat Portsmouth then the prediction is that Man Utd have a 77 percent chance of winning the match. But more on how you infer % chance from normal Betfair odds later.

Political Markets
Although every market on Betfair is a prediction in itself, some markets are more conducive in prediction terms than others. Generally speaking these tend to be the longer-term markets or the markets in which there is real academic or analytical knowledge around the subject matter. This guide will focus on politics.

Politics
Betfair's politics markets are the flagship prediction markets. They are heavily traded, both in terms of number of people and amount of money, and allow the real experts in the world to have an impact.

If you are an 'expert' on football, for example, you could analyse a match and come up with what your best guess of who will win is. But that is the thing - at the end of the day, it is always a guess. In politics, however, there are people betting who are experts in the very sense of the word: academics, politicians, political staffers, journalists, and so on.

These people know all there is to know about a certain market and make a decision based on this. You also have people involved who may be using information not available to the wider public and their opinion has much more influence on a prediction market.

Where the 2008 US Election is concerned we already have millions of pounds matched in our Democrat and Republican nomination markets and big sums in the Next President market, which we expect to continue rising as the weeks pass. In 2004, over £17 million was matched on the outcome of the Kerry v Bush election and back in the UK in 2005 more than £30 million was matched on the outcome of the General Election. Therefore, it would not be unusual to expect upwards of £40 million to be matched on this year's Presidential election - a huge amount and enough from which to confidently predict outcomes.

In opinion or exit polls those questioned don't have any motivation to be right, so they aren't accurate enough. In a prediction market or a stock exchange, many thousands of people have a vested interest in trying to be right. Therefore, prediction markets have a real value to add to the analysis of events, be they political or otherwise.

Other markets
Other markets that are particularly conducive to predictions include next managers markets, financial bets and special bets. These include:

- Climate bets

- Eurovision Song Contest

- Brit Awards

- Oscars

- BAFTAs

- Dancing on Ice

- Royal engagements

- UK Sports Personality

- X Factor

- Big Brother

- I'm a Celebrity Get Me Out of Here

How do I turn Betfair prices into a prediction percentage?
To change a Betfair price into a percentage requires a simple calculation:

1/Betfair price * 100 (1 divided by the Betfair price, multiplied by 100)

For example, the current next president market looks like this:

Barack Obama [2.08]
John McCain [3.2]
Hillary Clinton [5.5]
Mike Huckabee [180.0]

In the case of Barack Obama this means that his percentage chance of winning is 1/2.08*100 (1 divided by 2.08 - his Betfair price - multiplied by 100). Therefore, Obama is given a 48% chance of winning the Presidency by the Betfair market.

Politics Zone and Betfair Runner Graphs
The Betfair Politics Zone (politics.betfair.com) offers constantly updating access to graphs showing both % chance and odds. These graphs can be used to show how a price (or prediction) has evolved over time for specific markets.

Within the Betfair framework itself every runner has a small graph icon next to their name. If you click on it you can see odds or % chance over time for all individual selections for any market on Betfair.

So what's next?
This section of betting.betfair.com will have weekly columns showcasing our prediction capability week-by-week. It will also show examples of events in the past where the power of the market has resulted in a prediction ahead of the result that was in some way unusual or different than the general consensus.

The accuracy of prediction markets increase as the number of users increase, so why not get involved and get predicting?

Click here to be taken to the Betfair Politics Zone

Tags: betfair predictions, opinion polling, prediction exchange, prediction markets, predictions, trading exchange