Eric Zitzewitz

The Promise of Prediction Markets

The ability of groups of people to make predictions is a potent research tool that should be freed of unnecessary government restrictions.

Using Prediction Markets to Track Information Flows: Evidence from Google

Since 2005, Google has conducted the largest corporate experiment with prediction markets we are aware of. In this paper, we illustrate how markets can be used to study how an organization processes information. We show that market participants are not typical of Google’s workforce, and that market participation and success is skewed towards Google’s engineering and quantitatively oriented employees.

Who Cares About Shareholders? Arbitrage-Proofing Mutual Funds

As is becoming increasingly widely known, mutual funds often calculate their net asset values (NAVs) using stale prices, which causes their daily returns to be predictable. By trading on this predictability, investors can earn 35--70% per year in international funds and 10--25% in asset classes such as small-cap equity and high-yield and convertible bonds. These abnormal returns come at the expense of long-term shareholders, dilution of whom has grown in international funds from 56 basis points in 1998--99 to 114 basis points in 2001. Despite these losses and pressure from the Securities and Exchange Commission (SEC), the vast majority of funds are not market-updating their prices to eliminate NAV predictability and dilution, but are instead pursuing solutions that are only partly effective. The speed and efficacy of a funds actions to protect shareholders from dilution is negatively correlated with its expense ratios and the share of insiders on its board, suggesting that agency problems may be the root cause of the arbitrage problem. Copyright 2003, Oxford University Press.

When Should Firms Share Credit with Employees? Evidence from Anonymously Managed Mutual Funds

We study the choice between named and anonymous mutual fund managers. We argue that fund families weigh the benefits of naming managers against the cost associated with their increased future bargaining power. Named managers receive more media mentions, have greater inflows, and suffer less return diversion due to within family cross-subsidization, but departures of named managers reduce net flows. Naming managers became less common between 1993 and 2004. This was especially true in the asset classes and cities most affected by the hedge fund boom, which increased outside opportunities for, and the cost of retaining, successful named managers.

Nationalism in Winter Sports Judging and its Lessons for Organizational Decision Making

This paper exploits nationalistic biases in Olympic winter sport judging to study the problem of designing a decision making process that uses the input of potentially biased agents. Judges score athletes from their own countries higher than other judges do, and they appear to vary their biases strategically in response to the stakes, the scrutiny given the event, and the degree of subjectiveness of the performance aspect being scored. Ski jumping judges display a taste for fairness in that they compensate for the nationalistic biases of other panel members, while figure skating judges appear to engage in vote trading and bloc judging. Career concerns create incentives for judges: biased judges are less likely to be chosen to judge the Olympics in ski jumping but more likely in figure skating; this is consistent with judges being chosen centrally in ski jumping and by national federations in figure skating. The sports truncate extreme scores to different degrees; both ski jumping and, especially, figure skating are shown to truncate too aggressively; this may contribute to the vote trading in figure skating. These findings have implications for both the current proposals for reforming the judging of figure skating and for designing decision making in organizations more generally.

How Much Does Size Erode Mutual Fund Performance? A Regression Discontinuity Approach

The level of diseconomies of scale in asset management has important implications for tests of manager skill and the expected level of performance persistence. To identify the causal impact of fund size on future returns, we exploit the fact that small differences in returns can cause discrete changes in Morningstar ratings that, in turn, generate discrete differences in size. Despite robust evidence that Morningstar ratings increase fund size, our regression discontinuity estimates yield little evidence that fund size erodes returns. Consequently, any downward bias in standard estimates of performance persistence due to diseconomies of scale is likely to be small.

Regulation Fair Disclosure and the Private Information of Analysts

This paper reports evidence that Regulation Fair Disclosure has had its desired effect of reducing selective disclosure of information about future earnings to individual analysts without reducing the total amount of information disclosed. In particular, it finds that multi-forecast days, which typically follow public announcements or events, now account for over 70 percent of the new information about earnings, up from 35 percent before Reg FD. This result is obtained by applying a new methodology from Zitzewitz (2001a) for measuring the information content of individual forecasts. These results are strongest for the fourth quarter of 2000, when the SEC Chairman who introduced Reg FD was still in office; since the change in administration, some of the initial effects of Reg FD appear to have been reversed.

How Prediction Markets Can Save Event Studies

This review paper articulates the relationship between prediction market data and event studies, with a special focus on applications in political economy. Event studies have been used to address a variety of political economy questions - from the economic effects of party control of government to the importance of complex rules in congressional committees. However, the results of event studies are notoriously sensitive to both choices made by researchers and external events. Specifically, event studies will generally produce different results depending on three interrelated things: which event window is chosen, the prior probability assigned to an event at the beginning of the event window, and the presence or absence of other events during the event window. In this paper we show how each of these may bias the results of event studies, and how prediction markets can mitigate these biases.

Prediction Markets for Economic Forecasting

Prediction markets - markets used to forecast future events - have been used to accurately forecast the outcome of political contests, sporting events, and, occasionally, economic outcomes. This chapter summarizes the latest research on prediction markets in order to further their utilization by economic forecasters. We show that prediction markets have a number of attractive features: they quickly incorporate new information, are largely efficient, and impervious to manipulation. Moreover, markets generally exhibit lower statistical errors than professional forecasters and polls. Finally, we show how markets can be used to both uncover the economic model behind forecasts, as well as test existing economic models.

Information (In)Efficiency in Prediction Markets

We analyze the extent to which simple markets can be used to aggregate dispersed information into efficient forecasts of unknown future events. From the examination of case studies in a variety of financial settings we enumerate and suggest solutions to various pitfalls of these simple markets. Despite the potential problems, we show that market-generated forecasts are typically fairly accurate in a variety of prediction contexts, and that they outperform most moderately sophisticated benchmarks. We also show how conditional contracts can be used to discover the markets belief about correlations between events, and how with further assumptions these correlations can be used to make decisions.