Tuesday, January 08, 2008
Earlier on this blog, we shared some exciting early results from our firm's implementation of prediction markets. At last Friday's meeting of the American Economic Association, we shared the results of a deeper study, "Using Prediction Markets to Track Information Flows: Evidence From Google," that uses prediction markets to show how organizations process information and respond to external events. Here are some interesting findings:
- Traders in the same location tend to make the same trades at the same time. The trades of cubemates within a small radius is the best predictor we found. By using a record of historical office changes, we could observe that the correlation begins shortly after people are seated nearby. It makes sense, because the physical proximity enables easy communication. As Eric Schmidt (our CEO) and Hal Varian (now our Chief Economist) advised in 2005: "The best way to make communication easy is to put team members within a few feet of each other. No telephone tag, no e-mail delay, no waiting for a reply." As you can see below, our finding about the importance of proximity holds, even once we account for many other factors.
- Although we did find strong correlations among professional and social contacts, these were substantially weaker than the correlations for micro-geography. We also measured the influence that people on similar projects, in similar places in the organization and with similar demographic characteristics exert on each other. This helped establish that geographic proximity -- and not some other type of similarity -- was responsible for the correlations we saw.
- Despite the markets' strong forecasting abilities, there is a slight optimistic bias driven mainly by new employees. On average, outcomes that were good for Google were overpriced by 20%. This bias was strongest on days after appreciations in Google stock and, ironically, for outcomes under our own control! We also find biases against extreme outcomes and short selling. Given a range of five outcomes, the middle ones were typically overpriced and unprofitable by comparison with the outliers.