The big claim behind prediction markets is that they aggregate dispersed information into a single price. That price often behaves like a probability estimate of an event.
Why Markets Can Aggregate Information
Markets aggregate information because:
- Traders have different data, models, and instincts.
- Profit incentives reward correcting mispricing.
- Competing trades compress many opinions into one number.
In a good market, bad information gets priced out because someone will take the other side.
When Crowd Wisdom Works
Crowd wisdom is strongest when:
- There are many independent participants.
- Traders have diverse viewpoints and information sources.
- Incentives reward accuracy, not conformity.
- Liquidity is high enough for corrections to happen fast.
When Crowd Wisdom Fails
Crowd wisdom breaks when:
- Everyone shares the same narrative and blind spots.
- Participation is small and homogeneous.
- The market is dominated by entertainment traders.
- The event is hard to define or resolve objectively.
Markets can converge on a wrong probability if the information environment is wrong.
Practical Reading of Market Prices
Advanced interpretation includes:
- Watching how probability changes after new information.
- Comparing multiple markets that imply each other (consistency checks).
- Treating probabilities as ranges rather than exact values.
Key Takeaways
- Markets aggregate information through incentives, not through “wisdom.”
- Diversity and liquidity are the real drivers of accuracy.
- Market prices can be wrong for systematic reasons, not just randomness.