In the Operations management class that I teach this semester this week is dedicated to forecasting. While we mostly focus on methods, for example, time series and causal models, it is also important to think about business aspect of forecasting. That is – how do you make money doing it?
Suppose you are interested in predicting an election outcome.Traditionally, companies like Gallup or Rasmussen run surveys and polls, and this can be quite expensive. If you can substantially reduce costs, then you can lower price and compete successfully with bigger companies. How?
It is called prediction markets. The basic idea comes from sporting bets: if you make people bet money on the outcome then the odds ratio can be very telling about its chances.One can take it a step further and make a security whose payoff will be contingent on realization of the outcome. People will then buy and sell it, and its price will be equivalent to the probability of the outcome.
Two prominent companies that implemented this idea are Hollywood stock exchange and Intrade. Their business model is very similar to “hotels without rooms” and “car rentals without cars”, the companies I posted about before. I think the key feature of these innovations is that the companies are able to tap on resources that they do not own. In case of forecasting, by properly incentivising people to share their private information these firms effectively form a forecast which is based on a broad sample and information from multiple sources. All done at a very small cost.