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Economics & Finance - BLOG

The Price of Wise Forecasting

Miklos Sarvary |

Crowds are better at predictions than individuals. But when everyone is doing it, the need for individual experts remains.

Forecasting is important in every aspect of life and in business in particular. Grossly simplifying, the last two decades' academic research came to the general conclusion that crowds do better than individuals, the so-called "wisdom of crowds (WOC)" hypothesis. One of the resulting 'innovations' is the idea of prediction markets where people trade securities whose payoffs are tied to specific outcomes/events. Market prices provide 'superior' forecasts for the likelihood of the events in question. With social media broadly available to large and distributed populations, prediction markets are thriving.

Recent research conducted by IARPA seems to indicate that the WOC insight might be challenged - at least to some degree. Clearly, prediction markets do much better than the average expert participating in them. But it also seems to be the case that the top 2% of forecasters can beat the market by a relatively large margin. First, it seems that the elite forecasters do seem to do better systematically over time, so their performance is not just luck. Moreover, if you team them up, then together, they can beat prediction markets by 20-35%.

Prediction markets are cool forecasting tools but their weakness is that they give away the forecast, so in business where one wants to generate superior insights it is hard to discover proprietary information this way. But what if firms ran forecasting tournaments to discover the few experts that can provide sustainable advantage for them? Of course, the question then becomes: at what price will these experts share their views with the firm?

 

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Comments
Emile Servan-Schreiber,

"The top 2% of forecasters can beat the market by a relatively large margin."

This is a misreading of the research. It should read instead: "a prediction market populated by the top 2% of the forecasters can beat a prediction market populated by less skilled individuals".

Furthermore, the top 2% elite forecasters were themselves identified through their superior performance in a prediction market or another competitive forecasting process. The market elite is not to be confused with the regular media-friendly punditry.

Emile Servan-Schreiber

JMI,

Really interesting Miklos, thanks​!​

I think that you would be really interested in some recent research that I have come across explaining crowds and citizen science.​ ​In particular I feel you may find these two emerging pieces of research very relevant:

- The Theory of Crowd Capital
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2193115

- The Contours of Crowd Capability
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2324637

Powerful stuff, no?

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