'The Cleverness of Crowds' © Leighton Vaughan Williams

The Betfair Prof / Leighton Vaughan Williams / 17 December 2009 / Leave a Comment

"Prediction markets have been used to forecast what sometimes seems like almost everything, from the outcome of elections to the timing of influenza outbreaks to sales of the latest printer to box office receipts, and have often proved astonishingly accurate. But what does this really tell us about the 'crowd' and the market which reflects the views of the crowd?"

Got a question? Ask a group of people and you should get a strangely accurate answer

Undertaking an online search for dictionary definitions of the word 'Wisdom', I quickly came up with this: "The ability to use your experience and knowledge in order to make sensible decisions or judgments".

The second definition I hit upon gives the following: "The ability to discern or judge what is true, right, or lasting; insight".

There are plenty of dictionaries to skim, but these two definitions pretty much sum up what people usually mean when they use the word 'Wisdom'.

The two definitions I've highlighted are not identical, of course. It might, for example, be sensible from the point of a view of a jury wanting to go home to make a hasty and ill-considered decision about the defendant's guilt, but does this make their action wise?

The jury may indeed be acting wisely in their immediate personal interests but can we justifiably describe such behaviour as wise in a greater context? So when we say that a crowd is wise, what exactly are we saying and how does this fit in with the idea of a prediction market?

A classic example is that of 'Galton's ox', a seminal study in which Sir Francis Galton noted down the estimates of 800 or so entrants in a competition to guess the weight of an ox. He found that the average (mean) estimate of the crowd was almost exactly correct. Similar accuracy was reproduced in classic experiments in which students were asked to guess the number of jelly beans in a jar or the weight of a range of objects.

Prediction markets are essentially betting markets created for the purpose of making predictions. The idea behind the use of these markets stems from the view that information concerning the likelihood of future events is dispersed among many people, i.e. the 'crowd', and that these markets allow for the aggregation of this information.

Prediction markets have been used to forecast what sometimes seems like almost everything, from the outcome of elections to the timing of influenza outbreaks to sales of the latest printer to box office receipts, and have often proved astonishingly accurate. But what does this really tell us about the 'crowd' and the market which reflects the views of the crowd?

James Surowiecki extols the virtues of prediction markets in his book, 'The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies and Nations'. But does the success of prediction markets really tell us anything about the wisdom of the crowd? After all, there is a big difference between estimating the number of jelly beans in a jar and judging whether to put the defendant to death or go to war.

At a recent seminar I presented on December 7 at the University of Hamburg, my wife Julie May Vaughan Williams coined the phrase 'The Accuracy of the Crowd' as a better representation of what the empirical evidence tells us so far. As such, maybe we should see the crowd as clever rather than wise. To deduce something about its wisdom from its cleverness is perhaps a step too far. So let's coin a new phrase. Let's call it 'The Cleverness of the Crowd'. Citations please to Vaughan Williams and Vaughan Williams (December, 2009).