Prediction markets vs. Lokad

Published on by Joannes Vermorel.

In a previous post, I have been discussing the various worlds of forecasting software, outlining 3 main categories

  • Deterministic simulation software
  • Expert insights aggregation software
  • Statistical forecasting software

Lokad is clearly a member of the third category. Although, those three categories are not really competing with each other since they are usually not suited for the same type of situations.

In the second category, insight aggregation software, prediction markets software seems to attract more and more interest. Jed Christiansen has a very interesting review of prediction markets software

The overview page of Inlink provides an insightful summary about prediction markets

Prediction markets enable a diverse group of people to predict the answer to a question by buying and selling shares in stocks representing the possible answers. Using a stock market-like mechanism allows people to express their opinion as a "weighted vote" over time in response to new information or a change of opinion. And unlike a poll, a prediction market is asking "what will happen?" vs. "what do you want to happen?"

For example, if we ask the question: "Who will win the singing contest?" The four contestants would be represented as stocks that people buy shares in. If "Contestant A" has a stock price of $56, that means "the crowd" thinks there is a 56% chance that contestant will win. When people buy shares in that contestant, the price goes up. When they sell shares in that contestant, the price goes down. The stock price of an answer represents the probability of that answer being correct, priced stock after a period of time is considered the groups answer to the question posed.

The main difference with classical insight aggregation software is that the participants are financially involved in getting the right forecast.

Compared to Lokad (or to any statistical forecasting software), the main benefits of markets prediction is the ability to rationally tackle a forecast that depends on (potentially) irrational customer desires even when no relevant data is available. The crowd is bringing a solution to the small group of experts bias that usually plagues classical prospective methods such as the Delphi method.

Yet, like any insight aggregation method, market predictions involve quite an expensive forecasting process to get a single question answered. For example, it would not seem a very practical approach for call centers that requires 96 quarter-hour forecasts on a daily basis to predict inbound call volumes. If meaningful historical data is available, then statistical forecasts should be as accurate (if not more) and way much cheaper.

In its own statistical ways, Lokad is also (somehow) using the wisdom of the crowd, except that instead of considering a panel of people, we are considering a panel of business time-series that we exploit to improve the overall forecasting accuracy. In both cases, leveraging larger input datasets to improve forecasting accuracy is a key idea.

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