WEBVTT

00:00:00.000 --> 00:00:05.740
♪ [music] ♪

00:00:09.469 --> 00:00:11.829
- [Tyler] Today, we look
at a new type of market.

00:00:11.829 --> 00:00:15.299
A market which has been designed
to make predictions.

00:00:19.246 --> 00:00:22.263
In previous talks we discussed
how prices are signals

00:00:22.263 --> 00:00:24.054
that convey information.

00:00:24.054 --> 00:00:26.721
Information about where goods
have high value

00:00:26.721 --> 00:00:30.014
and where they have low value,
which goods have high value

00:00:30.014 --> 00:00:32.738
and which have low value
and so forth.

00:00:32.738 --> 00:00:36.536
Prices also can convey information
about world events,

00:00:36.536 --> 00:00:38.939
even predictions of the future.

00:00:38.939 --> 00:00:42.927
So, the orange juice futures price
for instance, implicitly contains

00:00:42.927 --> 00:00:46.134
a prediction
about the weather in Florida.

00:00:46.134 --> 00:00:49.170
It's not that these markets
were designed for this purpose,

00:00:49.170 --> 00:00:52.382
rather it's that speculators,
if they are to profit

00:00:52.382 --> 00:00:55.482
from movements in the price
of orange juice futures,

00:00:55.482 --> 00:00:58.725
have to make some predictions
about the weather in Florida.

00:00:58.725 --> 00:01:01.565
They have to know something
about the weather in Florida.

00:01:01.565 --> 00:01:03.957
So the price
of the orange juice futures,

00:01:03.957 --> 00:01:07.933
comes in part to reflect
the information that speculators

00:01:07.933 --> 00:01:11.255
hold about future weather
patterns in Florida.

00:01:11.466 --> 00:01:15.075
Indeed, economists and others
often have looked informally

00:01:15.075 --> 00:01:18.384
to market prices
to help make predictions.

00:01:18.384 --> 00:01:21.540
To help predict Florida weather,
they look to the price

00:01:21.540 --> 00:01:24.275
of orange juice
in the futures market.

00:01:24.275 --> 00:01:26.849
To help predict
Middle Eastern politics,

00:01:26.849 --> 00:01:29.953
they look to the price
of oil and oil futures.

00:01:29.953 --> 00:01:33.514
To help predict the consequences
of global climate change,

00:01:33.514 --> 00:01:35.545
they look to the price
of flood insurance

00:01:35.545 --> 00:01:37.363
in coastal regions.

00:01:37.363 --> 00:01:39.987
Now, in each of these cases,
the implicit prediction

00:01:39.987 --> 00:01:43.822
is just a by-product of the market
and indeed many other things

00:01:43.822 --> 00:01:47.801
are going on in these markets
which also influence the prices.

00:01:47.801 --> 00:01:51.218
The prices in these markets
are noisy predictors.

00:01:51.218 --> 00:01:54.879
They're rather imperfect predictors
because they weren't designed

00:01:54.879 --> 00:01:56.792
to only predict.

00:01:56.792 --> 00:01:59.670
What would happen if we design
the market explicitly

00:01:59.670 --> 00:02:01.503
to make predictions?

00:02:01.503 --> 00:02:03.577
Then the predictions we got
out of the market

00:02:03.577 --> 00:02:07.245
might be even more robust
and even more accurate.

00:02:07.245 --> 00:02:09.723
Let's take a look at some markets
which have been designed

00:02:09.723 --> 00:02:11.422
to make predictions.

00:02:11.876 --> 00:02:14.230
Prediction markets
are speculative markets

00:02:14.230 --> 00:02:16.839
which have been designed
so that the prices

00:02:16.839 --> 00:02:20.672
can be interpreted as probabilities
and used to make predictions.

00:02:21.049 --> 00:02:25.281
One of the most famous of these
is the Iowa Electronic Markets.

00:02:25.281 --> 00:02:28.093
I encourage you to go
to the web and check them out.

00:02:28.093 --> 00:02:32.176
Traders on the Iowa Electronic
Markets buy and sell shares

00:02:32.176 --> 00:02:35.777
of political candidates,
and the prices of the shares

00:02:35.777 --> 00:02:39.280
can be used to predict
the outcomes of elections.

00:02:39.739 --> 00:02:41.523
Let me give you an example.

00:02:41.995 --> 00:02:44.632
Here's the case
of the Iowa Electronic Markets

00:02:44.632 --> 00:02:47.837
from the 2008 election
between Barack Obama

00:02:47.837 --> 00:02:49.439
and John McCain.

00:02:49.439 --> 00:02:52.976
In these markets,
one Obama share pays you a dollar

00:02:52.976 --> 00:02:56.467
if Obama wins and pays you
nothing otherwise.

00:02:56.467 --> 00:03:00.098
One McCain share pays you a dollar
if you hold the share

00:03:00.098 --> 00:03:03.500
and McCain wins,
and pays zero if he loses.

00:03:03.936 --> 00:03:07.718
Now, suppose you think Obama
has an 80% chance of winning

00:03:07.718 --> 00:03:10.616
that election, how much
would you be willing to pay

00:03:10.616 --> 00:03:12.429
for an Obama share?

00:03:12.461 --> 00:03:15.759
Well, if an Obama share
pays a dollar if Obama wins

00:03:15.759 --> 00:03:18.464
and he has an 80% chance
of winning,

00:03:18.464 --> 00:03:21.146
then that share is worth 80 cents.

00:03:21.146 --> 00:03:23.222
You would be willing to pay
up to 80 cents

00:03:23.222 --> 00:03:24.994
for such an Obama share.

00:03:25.715 --> 00:03:28.109
Suppose you enter this market
and you find

00:03:28.109 --> 00:03:32.475
that these Obama shares
are selling for 65 cents,

00:03:32.475 --> 00:03:34.906
well, that's a buying opportunity.

00:03:34.906 --> 00:03:37.501
Something which you think
is worth 80 cents

00:03:37.501 --> 00:03:41.712
is selling for 65, so then,
you should buy Obama shares.

00:03:41.712 --> 00:03:44.944
In buying the shares, you would
be pushing up their price.

00:03:44.944 --> 00:03:48.875
In this way, your predictions,
your information, your opinions

00:03:48.875 --> 00:03:51.055
about which candidate
is likely to win

00:03:51.055 --> 00:03:54.557
become incorporated
into the price of an Obama share.

00:03:55.383 --> 00:03:59.357
By the way, suppose you thought
Obama had an 80% chance

00:03:59.357 --> 00:04:03.013
of winning but his shares
were selling for 90 cents,

00:04:03.013 --> 00:04:05.913
well then, you would want
to sell Obama shares.

00:04:05.913 --> 00:04:09.047
Even if you're an Obama supporter,
to make more money

00:04:09.047 --> 00:04:12.298
you would sell the Obama shares
and buy the McCain shares.

00:04:12.718 --> 00:04:16.356
Again, in this way, prices come
to reflect the information.

00:04:16.582 --> 00:04:19.055
There are lots of traders
in these markets.

00:04:19.055 --> 00:04:21.144
People who are
very politically astute,

00:04:21.144 --> 00:04:23.378
who understand
the electoral college

00:04:23.378 --> 00:04:25.355
and who understand
how elections work

00:04:25.355 --> 00:04:28.566
and how well or how badly
a campaign is going.

00:04:28.566 --> 00:04:31.372
When these individuals
buy and sell shares,

00:04:31.372 --> 00:04:33.902
their information comes
to be reflected

00:04:33.902 --> 00:04:35.659
in the market prices.

00:04:36.035 --> 00:04:40.273
Here are the actual prices
on August 8th, 2008.

00:04:40.273 --> 00:04:44.153
Obama shares were selling
for 63 cents per share

00:04:44.153 --> 00:04:47.727
and McCain shares
were selling for 37 cents.

00:04:48.036 --> 00:04:51.989
The market was predicting
a high likelihood of an Obama win

00:04:51.989 --> 00:04:55.162
and in fact, that did, of course,
turn out to be the case.

00:04:55.162 --> 00:04:57.854
In over 20 years of testing
these markets,

00:04:57.854 --> 00:05:00.933
in presidential elections,
congressional elections,

00:05:00.933 --> 00:05:03.749
and state elections,
these market prices

00:05:03.749 --> 00:05:06.628
from the Iowa Electronic Markets
have turned out

00:05:06.628 --> 00:05:08.927
to be better predictors
of the outcomes

00:05:08.927 --> 00:05:11.161
than have political polls.

00:05:11.491 --> 00:05:14.187
That makes a lot of sense.
Think about it.

00:05:14.187 --> 00:05:17.037
With real money on the line,
people have an incentive

00:05:17.037 --> 00:05:19.211
to think carefully
when they're investing

00:05:19.211 --> 00:05:21.716
and they have an incentive
to collect and process

00:05:21.716 --> 00:05:23.900
and interpret all
of the information

00:05:23.900 --> 00:05:26.758
from available all over the world.

00:05:26.758 --> 00:05:29.450
The resulting market prices
reflect a lot

00:05:29.450 --> 00:05:32.750
of deep-seated information
and indeed interpretation

00:05:32.750 --> 00:05:35.801
in a way which political polls
simply cannot.

00:05:36.589 --> 00:05:38.873
Similar prediction markets
have been creating

00:05:38.873 --> 00:05:40.605
all kinds of things.

00:05:40.605 --> 00:05:44.035
Some are pretty trivial things,
such as which actor or actress

00:05:44.035 --> 00:05:48.330
is going to win the next Oscar,
but also, firms have begun

00:05:48.330 --> 00:05:50.968
experimenting with prediction
markets to help

00:05:50.968 --> 00:05:54.567
from forecast variables,
like their future sales

00:05:54.567 --> 00:05:57.275
or which is the better decision,
or what will happen

00:05:57.275 --> 00:06:00.740
in some particular market
or some particular economy.

00:06:01.195 --> 00:06:03.598
Firms have been using
prediction markets

00:06:03.598 --> 00:06:06.272
to try to help themselves
make better decisions.

00:06:06.818 --> 00:06:08.605
Let's give an example.

00:06:08.605 --> 00:06:12.112
At the Hollywood Stock Exchange,
traders buy and sell shares

00:06:12.112 --> 00:06:16.218
and options in movies,
music, and Oscar contenders.

00:06:16.550 --> 00:06:19.653
Some 800,000 traders
do this for fun.

00:06:20.124 --> 00:06:22.682
They're using make-believe
"Hollywood dollars"

00:06:22.682 --> 00:06:24.914
but they still care enough
about the outcome

00:06:24.914 --> 00:06:28.519
to make the prices in these markets
pretty reliable predictors

00:06:28.519 --> 00:06:30.636
of future film profits.

00:06:30.636 --> 00:06:33.091
Now, although the traders
are doing this for fun,

00:06:33.091 --> 00:06:35.699
the website is owned
and run for profit.

00:06:35.699 --> 00:06:38.108
The information,
the implicit predictions

00:06:38.108 --> 00:06:40.936
in these prices,
that's valuable to studios

00:06:40.936 --> 00:06:43.924
who want to try and understand 
what's going to work

00:06:43.924 --> 00:06:46.592
in their next film
and what's not going to work.

00:06:46.919 --> 00:06:48.358
Here is an example.

00:06:48.730 --> 00:06:51.145
Some of us may believe
that sex sells,

00:06:51.145 --> 00:06:53.106
but is that actually the case?

00:06:53.106 --> 00:06:55.128
Well, on the Hollywood
Stock Exchange,

00:06:55.128 --> 00:06:58.335
we can be much more precise
using market prices.

00:06:58.950 --> 00:07:01.591
Here is some of the trading
for the movie

00:07:01.591 --> 00:07:04.591
"Fifty Shades Of Grey"
and you can see the price

00:07:04.591 --> 00:07:08.124
made a whole bunch of leaps
up and then leaps downward.

00:07:08.124 --> 00:07:11.557
That's reflecting changing
revenue estimates for the movie.

00:07:11.827 --> 00:07:14.463
A leap up came
when Charlie Hunnam was cast

00:07:14.463 --> 00:07:18.215
to play the title role in the movie
and then the price did go up.

00:07:18.215 --> 00:07:21.395
Later on, Charlie dropped out
and the price dropped

00:07:21.395 --> 00:07:23.289
right back down again.

00:07:23.289 --> 00:07:26.259
The prices in these markets
are important information

00:07:26.259 --> 00:07:27.583
for the studios.

00:07:27.583 --> 00:07:31.291
They tell the studios how much
are these actors really worth.

00:07:31.291 --> 00:07:34.180
If we hire this actor,
how much will revenue

00:07:34.180 --> 00:07:35.969
for the movie go up?

00:07:35.969 --> 00:07:38.318
Are people excited
about a particular actress

00:07:38.318 --> 00:07:41.628
in a particular role,
what about the director?

00:07:41.628 --> 00:07:43.916
By using the information
and the prices

00:07:43.916 --> 00:07:47.923
from the Hollywood Stock Exchange,
studios are able to better cast

00:07:47.923 --> 00:07:50.535
their movies and they
can make better decisions.

00:07:51.254 --> 00:07:54.084
No prediction process
has perfect accuracy,

00:07:54.084 --> 00:07:56.778
but the prices from the Hollywood
Stock Exchange

00:07:56.778 --> 00:07:59.815
turn out to be pretty useful,
especially when compared

00:07:59.815 --> 00:08:01.338
to other methods.

00:08:01.338 --> 00:08:05.222
Along here, we have predicted
opening revenues as shown

00:08:05.222 --> 00:08:08.336
by the prices on the Hollywood
Stock Exchange,

00:08:08.336 --> 00:08:10.914
and then here we have
actual revenues.

00:08:11.233 --> 00:08:14.309
If the predicted revenues
always equal the actual,

00:08:14.309 --> 00:08:16.974
well then, everything
would be along the red line.

00:08:17.319 --> 00:08:19.654
When the actual revenues
turn out to be more

00:08:19.654 --> 00:08:22.360
than predicted,
we're above the red line.

00:08:22.360 --> 00:08:24.776
So the original movie,
"Kings Of Comedy",

00:08:24.776 --> 00:08:28.242
was a smash hit because it did
much better than predicted.

00:08:28.242 --> 00:08:31.669
The movie, "The Adventures
of Pluto Nash" with Eddie Murphy,

00:08:31.669 --> 00:08:33.237
well that was a disaster.

00:08:33.237 --> 00:08:35.318
It did much worse than predicted.

00:08:35.600 --> 00:08:37.956
On average however,
the predicted revenues

00:08:37.956 --> 00:08:39.945
are pretty good indications

00:08:39.945 --> 00:08:42.193
of what the actual revenues
would be.

00:08:42.193 --> 00:08:45.426
And again, that's why the studios
look at these market prices

00:08:45.426 --> 00:08:48.350
because they are relatively
accurate predictions,

00:08:48.350 --> 00:08:51.098
more accurate
than other available measures.

00:08:51.372 --> 00:08:52.925
Alright, let's conclude.

00:08:53.187 --> 00:08:56.637
Market prices reflect information
and they convey information.

00:08:57.356 --> 00:09:00.777
Prices in futures markets,
can signal all kinds of things

00:09:00.777 --> 00:09:04.081
such as war in the Middle East,
cold weather in Florida,

00:09:04.081 --> 00:09:06.306
or who will win the next election.

00:09:06.306 --> 00:09:08.455
Prediction markets
are new types of markets

00:09:08.455 --> 00:09:11.457
which have been created
to help businesses, governments,

00:09:11.457 --> 00:09:14.103
and scientists
predict future events.

00:09:14.449 --> 00:09:16.151
Market prices are good ways

00:09:16.151 --> 00:09:18.351
of aggregating dispersed
information

00:09:18.351 --> 00:09:23.080
and summarizing that information
in a single key figure, the price.

00:09:23.614 --> 00:09:25.351
Thanks.

00:09:25.956 --> 00:09:27.600
- [Narrator] If you want
to test yourself,

00:09:27.600 --> 00:09:29.578
click Practice Questions,

00:09:29.578 --> 00:09:33.254
or if you're ready
to move on, just click Next Video.

00:09:33.254 --> 00:09:37.637
♪ [music] ♪