Academic journal article Harvard Law Review

Prediction Markets and Law: A Skeptical Account

Academic journal article Harvard Law Review

Prediction Markets and Law: A Skeptical Account

Article excerpt

Enthusiasm for "many minds" arguments has infected legal academia. Scholars now champion the virtues of groupthink, something once thought to have only vices. (1) It turns out that groups often outperform individuals in aggregating information, weighing alternatives, and making decisions. And although some of our legal institutions, such as Congress and juries, already harness the power of the crowd, others could be improved by multiplying the number of minds at work. (2) "Multiplying" implies a simple mathematical formula for improving decisionmaking; modern many minds arguments are more sophisticated than that. They use incentive analyses, game theory, and statistics to study how and under what circumstances groups make better choices than individuals do. The models propose to solve various information problems, such as determining guilt or innocence, (3) deciding on a course of regulation, (4) or estimating a value that is difficult to measure directly. (5)

Most ambitious, perhaps, has been the attempt to aggregate knowledge to predict the future. Uncertainty is a painful part of reality; it is only natural that the wisdom of the crowd would be summoned to battle it. The most popular model on that front has been the "information market" or "prediction market." (6) (The terms can be used interchangeably.) In particular, scholars have argued that such markets may alleviate uncertainty in legal and policy analysis. (7) This Note argues that enthusiasm for prediction markets in law is misplaced. No one thinks prediction markets are perfect; even their proponents concede that they will fail under certain circumstances. But with their concessions they give up the game, at least as applied to legal problems: the circumstances in which prediction markets are inaccurate are precisely the circumstances in which law needs them most.

Part I surveys information markets--their success stories and their limitations. Part II begins by outlining the ambitions scholars have for information markets and law. Part II then develops the thesis of this Note: that the performance of prediction markets is inversely correlated with how valuable their predictions would be. This Part argues that if a future event is secret or knowledge about its likelihood is thin, if it depends on the idiosyncratic action of an individual, or if it is catastrophic but unlikely, a prediction market will probably not produce accurate information. Finally, Part III defines the niche, smaller than scholars imagine, in which prediction markets shine.

I. INFORMATION MARKETS

A. How Information Markets Work and When They Work Well

Information markets use the power of price to aggregate information into a single estimate of the likelihood of an occurrence. (8) The market is a forum, typically online, in which participants place bets on the outcome of events. (9) Each participant owns a set of contracts, or shares (to use a stock market analogy), that promises to pay out if an event occurs. The payout can be defined in a variety of ways depending on the design of the particular market, (10) but in any case the owner of a contract stands to gain money from the fruition of his bet. A participant can trade contracts with other participants, and so he can make money either by receiving a payout or by selling the share at a price that exceeds his purchase price. (11)

The information that an information market produces is the price of the traded contract. (12) For example, if shares of "Revolutionary Road wins Best Picture" are selling at $0.45, and that contract promises to pay its owner $1 if the prediction comes true, then the price reflects a belief that Revolutionary Road is 45% likely to take home the award. But this trading price is more useful, that is, more reliable, than an individual film critic announcing his belief that Revolutionary Road is 45% likely to take home the Oscar, for two reasons. First, the price the critic paid for the share may be more reliable than his stated prediction because as a self-interested market participant, his interest in making money should counteract any bias that he has. …

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