Exploring Efficient Markets

13. You can find more about some of the topics discussed in this chapter with careful searches on the internet.

a. Search the Internet for "efficient-market hypothesis." How is it defined? Why are people writing about it?
b. Search the Internet for "greater fool." In what markets may fools be lurking?
c. Search the Internet for "market bubbles." In what markets are they thought to exist or to have existed? Have any popped lately?
d. Search the Internet for "behavioral finance." How is it related to the topic of this reading selection?

14. Economists rather quickly realized that the efficient-market hypothesis should not apply only to financial markets, but should also apply to other markets. It should work, for example, in sports betting. If bettors as a group make predictable errors, then there should be a way to enter the market and make money. Once people start exploiting this discrepancy, it will tend to close up. And in fact economists have tested betting markets to see if there are ways to exploit any mistakes.

Some economists took the idea a bit further and asked it it would be possible to use the idea for making predictions. Out of this was born the Iowa Electronic Markets at http://www.biz.uiowa.edu/iem/. The main item traded (or bet) here has been political races. In fact these markets have done as well as or better than professional polls. Economists have studied these markets as well, and there is even an academic journal devoted to publishing research about them: http://www.predictionmarketjournal.com/

The idea has spread and the largest prediction market now seems to be intrade at http://www.intrade.com/.

Look at these markets. They make predictions on politics, economic statistics, war, Federal Reserve policy, and many other things. What is the most unusual market that you can find? Can you think of any use that these markets might have for you now or in the future? Can you think of any way a business could use these markets?

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