A Primer on Information Markets

In 1988 the US Commodity Futures Trading Commission gave permission for the University of Iowa to begin operating the Iowa Electronic Market (IEM) thus ushering in the world's first information market (sometimes called a prediction market). Similar markets have subsequently appeared at the University of British Columbia and Vienna University of Technology. Outside the education sector firms such as Trade Exchange Network (tradesports.com) and a joint venture between Goldman Sachs and Deutsche Bank (economicderivatives.com) have set up public information markets while other firms such as Hewlett-Packard Lilly and Siemens have used information markets for internal purposes. Information markets are similar to standard derivatives markets in that they provide a mechanism for trading financial claims to future contingencies. However they differ in that first they are more accessible to small investors and second they offer markets on a wider range of events including politics sports legal weather business and entertainment. The increasing popularity of information markets reflects several factors. The university-based markets were initially designed to serve primarily as teaching and research tools by providing students and staff with the opportunity to study a trading environment that is more realistic than the typical laboratory setting but without the scale complexity and noise of real-world markets. More recently based on the proven ability of markets to gather and assimilate dispersed information the potential forecasting power of information markets has generated most interest.In this paper we describe the structure of some existing information marketsoutline their key features explain what they can be used for and assess theirpredictive ability. Finally we consider the possible advantages of setting up of an information market in New Zealand.