Brexit: what do prediction markets tell us about its likelihood?
1 What are prediction markets?
Prediction markets allow the exchange of contracts where the financial return is dependent on the (currently unknown) outcome of future events. They exist in a wide range of forms. Perhaps the best-known examples of pure prediction markets are the election forecasting markets run by the University of Iowa.2 For instance, using this exchange, an investor can buy an asset for any of the potential US presidential election nominees of the Republican and Democrat parties. Should that potential nominee become the actual nominee, the asset pays out $1; otherwise it pays out nothing.3
Such markets are closely linked to other entities such as traditional bookmakers; however, subtle differences exist—prediction markets match traders willing to buy and sell outcome-dependent contracts, whereas a bookmaker sells contracts itself (the terms of the contract are the odds the bookmaker offers).
The prevailing prices in these markets can be interpreted as indicating information about the probability of that outcome occurring. For instance, the price of an asset paying $1 if Hillary Clinton becomes the Democrat nominee is approximately $0.84, over eight times the price of an asset conditioned upon Bernie Sanders becoming the nominee,4 representing her status as the most likely nominee.
Contact: David Jevons