The Role of Feedback in the Assimilation of Information in Prediction Markets

Abstract

Leveraging the knowledge of an organization is an ongoing challenge that has given rise to the field of knowledge management. Yet, despite spending enormous sums of organizational resources on Information Technology (IT) systems, executives recognize there is much more knowledge to harvest. Prediction markets are emerging as one tool to help extract this tacit knowledge and make it operational. Yet, prediction markets, like other markets, are subject to pathologies (e.g., bubbles and crashes) which compromise their accuracy and may discourage organizational use.The techniques of experimental economics were used to study the characteristics of prediction markets. Empirical data was gathered from an on-line asynchronous prediction market. Participants allocated tickets based on private information and, depending on the market type, public information indicative of how prior participants had allocated their tickets. The experimental design featured three levels of feedback (nofeedback, percentages of total allocated tickets and frequency of total allocated tickets) presented to the participants.The research supported the hypothesis that information assimilation in feedback markets is composed of two mechanisms -information collection and aggregation. These are defined as:• Collection -The compilation of dispersed information -individuals using their own private information make judgments and act accordingly in the market. ii• Aggregation -The market's judgment on the implications of this gathered information -an inductive process. This effect comes from participants integrating public information with their private information in their decision process.Information collection was studied in isolation in no feedback markets and the hypothesis that markets outperform the average of their participants was supported. The hypothesis that with the addition of feedback, the process of aggregation would be present was also supported. Aggregation was shown to create agreement in markets (as measured by entropy) and drive market results closer to correct values (the known probabilities).However, the research also supported the hypothesis that aggregation can lead to information mirages, creating a market bubble.The research showed that the presence and type of feedback can be used to modulate market performance. Adding feedback, or more informative feedback, increased the market's precision at the expense of accuracy. The research supported the hypotheses that these changes were due to the inductive aggregation process which creates agreement (increasing precision), but also occasionally generates information mirages (which reduces accuracy).The way individual participants use information to make allocations was characterized.In feedback markets the fit of participants' responses to various decision models demonstrated great variety. The decision models ranged from little use of information (e.g., MaxiMin), use of only private information (e.g., allocation in proportion to iii probabilities), use of only public inform...