The Science Behind PPX

And so, getting back to NASA, if we want to know whether the space agency will complete the ISS, we should consolidate into a single price all the available knowledge about the project and then start trading. Here's how it works: We create a security (the "proposition") that asserts: "NASA will complete building the ISS by the end of 2010." If, at the end of 2010, NASA has indeed completed ISS construction, everyone holding that security receives $100. But if it does not finish, everyone holding that security gets zilch. Between now and then, anyone can buy and sell that proposition for an ever-fluctuating amount of money between $0 and $100. If you think it's 60 percent likely that NASA will finish, you'd be willing to bet up to $60 in order to earn that $100. Therefore, you'd buy that proposition if it was selling for $60 or less. If you lost confidence, you'd look to sell.

In a market set up like this, a proposition trading at $75 means that there's a 75 percent chance that the proposition will turn out to be true. But the amazing thing about these markets is that they're not just one effective way to forecast what's going to happen; they're the best predictors of future events. "We have yet to find any domain where experts beat the market on predicting the future," says Justin Wolfers, a professor at the University of Pennsylvania's Wharton School of Business. "When I talk to people who are not economists, they find that amazing, but if your expectations are better than the market's, then let's go bet on the market," because if you have information that indicates that the market price is incorrect, then there's easy money to be made. Or: If you're so smart, why aren't you busy getting rich?

A GROWTH MARKET

Inspired by the success of the Iowa markets and enabled by the networking power and efficiency of the Internet, innovators have been coming up with ever more creative ways of using markets to predict the future. The Hollywood Stock Exchange sprang up in 1996 to let amateur moguls bet on a movie's opening-month box office. Companies like Hewlett-Packard and Microsoft created internal markets so that employees could bet on how well a new product was going to sell or whether an important project would meet its deadline (senior management was often disappointed to learn the cold, inevitably accurate judgment of the market). Offshore gaming sites like intrade.com started offering nonsports gambling along with NFL and baseball futures. At one point in 2003, anyone in the world could go online to buy shares of contracts that would pay off if the U.S. ousted Saddam Hussein, Special Forces killed Osama bin Laden, or a jury of his peers convicted Kobe Bryant.

Convinced of the power of such markets to predict the future, researchers are now exploring how to expand the markets' reach. They're investigating techniques that use markets to divine the consequences of yet-to-be-made decisions. If these "decision" markets take off, we won't just be able to see the future, we'll know how to bend it to our will.

ASK THE RIGHT QUESTION

During the buildup to war in Iraq in 2003, pundits filled the 24-hour news cycle with predictions about what would happen once the U.S. invaded. Either the Americans would be greeted as liberators, or they would ignite an endless war that would consume the Middle East. Gas prices would go up, or they would go down. The economy would soar or swoon, and no one could offer anything more than arguments as to which would be the case.

One problem with these predictions was just how predictable they were: Hawks claimed that success was inevitable, doves warned of impending doom. People believed what they wanted to believe, because there was really no hard data clearly linking an immediate decision with a particular outcome. Ultimately, the only way to find out what would happen if the U.S. were to go to war with Iraq was to go to war and see. History would judge.

Yet history is slow. What we want, what the people making important decisions need, are methods more powerful than partisan argument and inference to guide those decisions. They need a little mirror to help them see around the corner of the future, no matter how incomplete that view may be.