Innovations in Defense Acquisition: Asymmetric Information, Mechanism Design and Prediction Markets

Abstract

Prediction markets, sometimes called information markets, idea markets or event futures, are similar to financial stock markets where the stocks and their prices reflect the consensus view regarding the outcomes of specifically defined future probabilistic events. Prediction markets quickly and efficiently gather and summarize information from a disparate and diverse group of people, providing a two-way information flow; individual traders are informed by the consensus opinion and their market decisions inform the aggregate consensus. The remarkable accuracy of prediction markets in forecasting election results, economic outcomes, and other variables has defense managers intrigued by the possibility of applying these markets as a managerial decision tool. Overall, implementing prediction markets is straight forward, but in practice the devil is in the details, including security or contact design, trading rules, participation incentives, and the number and characteristics of the traders. Small changes in any design element can significantly affect prediction market performance. This research highlights the implementation issues involved in designing and running prediction markets. If improperly designed, prediction markets will be confusing and uninformative, at best. Poorly designed early pilots can portray prediction markets as a flawed concept as opposed to a useful concept with a flawed implementation.