Iowa Electronic Markets
After 280 years of development, the kind of products traded via futures contracts have grown increasingly varied. They broadly can be put into the following categories: agricultural (especially grains), metals (such as gold, silver and copper), energy (crude oil and its derivatives), and soft futures (cocoa, coffee and other specialty crops). Factors that can influence prices for these futures include the weather, supply and demand in the area where the commodity is produced, government policies, international market fluctuations and so forth.
The rise or fall of the price of a futures contract could be described as representing a change in the "collective prediction" about the future price of that commodity. In fact, the economist Friedrich August von Hayek, who won the Nobel Prize for economics in 1974, essentially said as much back in 1945: "The mere fact that there is one price for any commodity brings about the solution which... might have been arrived at by one single mind possessing all the information which is, in fact, dispersed among all the people involved in the process."
The idea of price reflecting information is behind the "prediction markets" that came into being many decades later. Moreover, "prediction markets theory," which uses market mechanisms to make observations about various social trends, has for two decades been growing by leaps and bounds around the world.
The world's first predictions market was the Iowa Political Stock Market, which was founded by three professors-George R. Neumann, Robert Forsythe, and Forrest Nelson-at the University of Iowa's business school in 1988. The professors were pushed to action after Jesse Jackson, an African-American that was behind in the polls, wound up winning the Democratic primary in Michigan with 55% of the vote.
Harboring doubts about the accuracy of polling, the three Iowa economists came up with their path-breaking concept by extending the economic theory that regards market prices as manifestations of "collective consciousness." It was the first time that the economic model of commodity futures markets was used as a blueprint for creating an exchange to predict election outcomes.
So as to get participants to take a more diligent attitude to these "trades," the founders had to jump through bureaucratic hoops to get authorization for players to use real money (with the amount that any one player can invest restricted to a range of US$5-500). Playing with real money, it was thought, would get people to throw themselves more diligently into this new activity.
At first, participation in the Iowa Political Stock Market was restricted to students and professors, but after its accuracy engendered a lot of interest, in 1992 its name was changed to the Iowa Electronic Market, and participation was opened up to "players" from around the world. Moreover, contract topics were no longer restricted to America itself. For instance, in 1999 two kinds of contracts were offered about the following year's presidential elections in Taiwan. The first predicted who would win the election, and the second predicted the share of the votes that the three main candidates would receive.
When the market closed on March 16 of 2000, the prices for the first set of contracts showed Chen Shui-bian's chance of winning at 55%, James Soong's at 38%, and Lien Chan's at 28%." The second set of contracts, which estimated vote totals, had Chen getting 39%, Soong 37.5%, and Lien 26%. In the actual election, they ended up at 39.3%, 36.8% and 23.1%. The Iowa market was pretty close to hitting the bullseye.
At this summer's soccer World Cup, the Spanish team, despite losing to Switzerland in group play, performed brilliantly from the round of 16 on. It ended up the eventual champion. For the finals, the Exchange of Future Events, like Paul the Psychic Octopus, predicted that Spain would win. Spanish victory contracts ended up trading for as high as NT$65.8. (left:) Paul the Octopus, whose unbroken run of eight accurate predictions brought him global fame during the World Cup. (facing page:) The Spanish team celebrates.