James Surowiecki's book, Wisdom of Crowds, captures the logic underlying prediction markets.

There’s been a lot of controversy over Obama allegedly saying he wants to spread peoples’ wealth around.  Something about class warfare or whatever.  It’s all over my head.  I don’t grasp the subtleties of Obama’s tax plan (nor do most people), but I do know that I’m going to make about $80 off the backs of other hardworking Americans when Obama wins the election.  It might not be too late for you to profit from Obama’s victory too.

Intrade.com is a “prediction market” where people around the country bid real money on the likelihood that an event will happen in real life, such as the Democrats gaining 60 seats in the Senate or the Republicans being raptured into heaven on the eve of the apocalypse.  It’s similar to a futures market, except here you’re bidding on events rather than commodities.  You buy “contracts,” paying a price equivalent to how likely you think something will happen.  If the event doesn’t happen, your contract will be worth zero points, but if the event does happen then your contract is worth 100 points.  Each point is worth a dime of real money.

Part of the fun is that Intrade reflects the wisdom of a lot of people who have a real financial stake in the outcome.  This concept is premised on the idea that, collectively, crowds of people are wiser than individuals.  Of course, there are a lot of problems with this idea.  Sometimes crowds are uninformed, don’t have the proper incentives to make wise decisions, or are manipulating the market.  But if you are paying close attention to the news (or, in my case, a cursory amount of attention), you can have fun and make a couple bucks in additon to knowing what will happen with more certainty than your friends.

Intrade seems to be a place where some of the problems with collective wisdom are mitigated and it has proven to be accurate at predicting real-world events far into the future.  Of course, part of the prediction market is that it becomes more accurate as the event approaches.  As the event draws nearer, the markets polarize.  As you can imagine, some contracts are very cheap now that the election is getting closer.  For instance, Hillary Clinton winning the presidency used to be trading around 40 points, but now it’s down to about 1 point.

Since we now know that Barack Obama will almost certainly win the presidency, prices on President Obama contracts are rising quick.  They used to cost almost nothing back when Obama was struggling to get his name out early in the primary season.  But last week, I bought about 30 contracts at 73 points each.  So when Obama wins on November 4th, they’ll each be worth 100 points, meaning I’ll make a profit of about $80 in real money. 

It’s not too late to help Obama spread other peoples’ wealth into your wallet.  He’s trading at about 84 points, meaining that people still only believe there is an 84% chance he will win.  Although you’ll make enough money for a night at the bar, part of the fun is just watching what the collective internet wisdom is and how it evolves over time.  Go try it for yourself.