A prediction market is a bit like the stock market, except that you are buying shares whose value depends on the success of a political candidate, rather than the profits earned by a corporation. And just as stock prices are a useful barometer of the health of a company, so too the price of a prediction contract is a barometer of the health of a political campaign….
How do these markets work? Right now, you can buy a $1 bill for 44 cents; the only catch is that you only get the $1 if Hillary Clinton is our next President. The fact that this $1 bill is selling for 44 cents tells us that “the market” believes her to have a 44% chance of winning the presidency, a number that has risen sharply as she has become more likely to win the Democratic nomination. Interestingly, prediction markets have long suggested a strong showing for Ms. Clinton, even as popular commentators had earlier dismissed her as unelectable….
That is from University of Pennsylvania economist Justin Wolfers, who is writing about prediction markets and the U.S. presidential campaign this year for the Wall Street Journal. The initial article in the series provides a good introduction to the topic including links to a few key papers.