Prediction markets (also known as predictive markets, information markets, decision markets, idea futures, event derivatives, or virtual markets) are exchange-traded markets created for the purpose of trading the outcome of events. The market prices can indicate what the crowd thinks the probability of the event is. A prediction market contract trades between 0 and 100%. It is a binary option that will expire at the price of 0 or 100%. Prediction markets can be thought of as belonging to the more general concept of crowdsourcing which is specially designed to aggregate information on particular topics of interest. The main purposes of prediction markets are eliciting aggregating beliefs over an unknown future outcome. Traders with different beliefs trade on contracts whose payoffs are related to the unknown future outcome and the market prices of the contracts are considered as the aggregated belief.
Before the era of scientific polling, early forms of prediction markets often existed in the form of political betting. One such political betting can date back to 1503, where people would bet on who will be the papal successor. Even then, it was already considered “an old practice”. According to Paul Rhode and Koleman Strumpf, who has researched the history of prediction markets, there are records of election betting in Wall Street going back to 1884.”. One study estimates that average betting turnover per US presidential election is equivalent to over 50 percent of the campaign spend.
Economic theory for the ideas behind prediction markets can be credited to Friedrich Hayek in his 1945 article "The Use of Knowledge in Society" and Ludwig von Mises in his "Economic Calculation in the Socialist Commonwealth". Modern economists agree that Mises' argument combined with Hayek's elaboration of it, is correct . Prediction markets are championed in James Surowiecki's 2004 book The Wisdom of Crowds, Cass Sunstein's 2006 Infotopia, and How to Measure Anything: Finding the Value of Intangibles in Business by Douglas Hubbard. The research literature is collected together in the peer reviewed The Journal of Prediction Markets, edited by Leighton Vaughan Williams and published by the University of Buckingham Press. The journal was first published in 2007, and is available online and in print.