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Markets

Question? Ask the Crowd

Whether forecasting company sales or election results, prediction markets just may have the answer.

Next time you're asked to guess the number of pennies in a jar, see if you can learn all the other guesses and use the average. You'll come close. When you gather the opinions of the many, the consensus usually trumps the opinions of the few -- even renowned experts. That's the hypothesis behind the Efficient Market Theory, gospel to many on Wall Street, which holds that few people can consistently beat the market over time because prices already reflect investors' collective beliefs -- the basis of the hugely successful index-fund business. That's also why the audience poll on Who Wants to Be a Millionaire gets it right more often than the "phone a friend" option.

No wonder many smart people think "prediction markets" will spread through business, finance and, eventually, government. Watch for them to factor in more decisions -- even a company's choice of its next CEO or whether it should agree to a merger. On another level, these markets let you invest in or speculate on many outcomes for fun or profit. You can open an account at HedgeStreet.com for just $100 to trade low-cost futures on the value of housing or gasoline prices. NewsFutures.com lets you put play money on the President's approval rating.

Just watching prediction markets is instructive. Perhaps the oldest and best-known example of a prediction market is Iowa Electronic Markets, which has prognosticated presidential elections -- better than the polls -- since 1988. The Trade Exchange Network, based in Ireland, claims 65,000 traders in 125 countries and trades 2,000 contracts, including ones that predict whether avian flu will strike the U.S.

Or take another hot topic: real estate. The Chicago Mercantile Exchange is about to trade futures contracts on home prices. The contracts are designed for developers and lenders who want to balance their financial risk in big real estate markets, such as Boston, Las Vegas and Miami. But if you live in one of these areas, the value of the futures can help you gauge property values and determine whether you want to buy or sell.

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Confusion surrounds the regulation of public prediction markets. They are governed by state gambling laws, federal commodities laws, foreign laws or no laws at all. Markets run within companies aren't as encumbered as public markets, so that's where they may catch on fastest, relying mostly on the opinions of employees. Hewlett-Packard has used the markets to refine forecasts, and Microsoft to predict when a software-testing tool would be ready. Other firms are reaching out. Corning invited industry insiders to trade LCD-TV futures. Anyone can trade virtual stock in technologies of the future in Yahoo Research's Tech Buzz game. Economics professor Robin Hanson, of George Mason University, says that 20 years hence, prediction markets will be commonplace for even the most crucial corporate decisions.