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HBX Business Blog

The Power of Prediction Markets

Posted by Ben Chowdhury on April 14, 2016 at 10:23 AM


Who do you think the next President of the United States will be? What about the winner of the 2018 World Cup? You probably have a guess, or at least a list of possible results. But no one actually knows for sure. 

Some situations have such complex dynamics that even think tanks and advanced modelling software have trouble understanding them. For example, imagine you are trying to estimate the box office results of an upcoming major film. You have some historical data on how similar films have done at the box office, but every film is different and is released in a different economic climate. You want to incorporate all of the various factors that affect the success of a film: advertising expenditures, the cast, demographic appeal, date of release, and so many other variables that you couldn’t possibly list them all, let alone measure them.

It turns out that one of the best predictors of box office results is the Hollywood Stock Exchange, or HSX. The HSX is a virtual market where anyone (you and I included) can sign up, get H$2 million in fake Hollywood dollars, and start betting on all kinds of Hollywood-related outcomes (e.g. Oscar nominations and box office results). The way it works is simple: The Jungle Book is currently selling for H$187.51 which means that the market expects The Jungle Book to earn $187.51 million in the first four weeks of its release. If I think The Jungle Book will actually make more than this, I can buy this MovieStock® at H$187.51 and then I can cash out my MovieStock four weeks after release for however much the actual box office earnings were (divided by $1 million and in Hollywood dollars). Just like a real stock market, the price of a MovieStock fluctuates with trading and I can always sell my MovieStocks for their current value before the cash out date.

The HSX is a great example of a prediction market. Prediction markets are markets where people can trade stocks that are tied to the outcome of an event. In a prediction market, the current trading value of a particular stock can be interpreted as what the public (or group of traders) collectively predict the outcome of the event to be. 

These prediction markets can be quite powerful. There is a significant amount of literature showing that HSX quickly absorbs new information (such as casting decisions) and accurately predicts box office results. HSX also has a history of correctly predicting Oscar nominations. There are dozens of prediction markets for events ranging from elections to sporting events with thousands of stocks being traded in real time. Many use real money and most are open to the public. While we don’t recommend “gambling” in these markets, we do recommend checking them out and thinking about their value and their limitations.

Want to learn more about prediction markets as well as other fundamental business topics?

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Topics: HBX CORe, HBX Insights