Prediction Markets: A Review with an Experimentally Based Recommendation for Navy Force-shaping Application

Prediction markets generally are small-scale electronic markets that tie payoffs to measurable future events. They are similar to stock markets, where the stocks are outcomes or events rather than shares in a company. The growing popularity of prediction markets reflects the notion that markets are an excellent means of efficient information aggregation among a disparate group of people. Trading prices in the prediction markets provide decision makers with a timely, accurate, and continuously updated picture on the likelihood of future events. This enables decision makers to better evaluate risk. Based on historical successes in prediction market utilization, it is both logical and important to assess the usefulness of prediction markets in contributing to critical elements of Navy total force shaping. Navy Manpower, Personnel, Training, and Education (N1) regularly forecasts re-enlistment rates, over/under endstrength, and many other force-shaping factors as an input into their resource allocation decision-making process. In an effort to improve upon the force-shaping decision-making process, N1 has shown interest in using prediction markets to complement or replace alternative methods for forecasting various Navy force-shaping elements. The aim of this thesis is to act as a foundation for ongoing prediction market research within the Department of Defense (DoD). The original document contains color images.