January 6, 2008
Posted by Jay Livingston
There’s been some discussion of prediction markets at sociology blogs like Statistical Modeling and
Scatterplot.
Prediction markets are like stock markets: in stock markets, investors are betting on the ultimate price of a stock; in prediction markets they are betting on the outcome of events like elections, Academy Awards, American Idol, or when the US will start withdrawing troops from Iraq.
The collective wisdom of the investors is reflected in the price of the different options. If you want to buy shares in Obama as the Democratic nominee, you have to pay a higher price now than you would have three days ago.
The question is whether that collective wisdom has more predictive power than do the so-called experts.
Sports betting is essentially a prediction market. The odds or the betting line reflects the collective wisdom of the bettors (or “investors” – the term applied to people who bet on stocks). I blogged about this
a year ago, and I came down on the side of the experts – the bookies and oddsmakers who set the initial line.
Yesterday’s NFL games offered a good example (i.e., anecdotal evidence) of what I meant. The oddsmakers made the Seahawks a 4-point favorite over Washington. But the public bet Washington, and the line came down to 3. The Seahawks covered easily, winning by 21. The crowd lost.
The Steeler game was an example of the worst-case scenario of following the “wisdom of crowds.” The Jaguars opened as 1 point favorites. The public bet them heavily, and by game time, the line was 3. If you had bet the Jaguars early in the week, you would have given up one point. But suppose you had waited to see wisdom of the crowd. You see the line going up, you see that the collective wisdom is heavily in favor of the Jaguars, and on Saturday you put down your bet, giving the Steelers 3 points.
The Jaguars won but by only two points. Following the wisdom of the crowd turned a winning bet into a losing bet. (That was cold comfort for us Steeler fans, who may have won our bets but saw our team lose a heartbreaker.)
In today’s games, the 3-point line on the Bucs and Giants hasn’t moved, at least not as of this morning. But in the Chargers-Titans game, the public has been favoring the Chargers. The line opened at 9 and is now up to 10 at most bookmakers. If you believe in the wisdom of crowds, you bet the Chargers. If you think the oddsmakers are smarter than the public, you bet the Titans plus ten points.