Can expert prediction markets forecast climate-related risks?

Abstract

Prediction markets use a betting-like mechanism to aggregate information from disparate sources to produce probability forecasts that represent the collective view of participants. They have similarities with financial markets but are designed specifically to discover information rather than transfer assets or risks. Contracts that pay out a fixed amount if a well-defined event occurs are traded in these markets and, under certain conditions, the price at which these event-contracts trade can be interpreted as a probability estimate that the event will occur. This article examines the performance of 24 prediction markets for climate-related variables that have been run over the past five years. The predicted variables included monthly temperature and rainfall for the U.K., an index of El Niño-Southern Oscillation, Atlantic hurricane activity, and U.K. wheat yield. The markets had horizons of 2 to 12 months. Invitations to participate in the markets were extended to individuals and teams with relevant expertise. Participants did not have to pay to take part but did receive cash rewards based on their performance. Trades were made through an automated market maker overcoming the problems of low activity that have affected previous prediction markets for specialized topics. The predictions of the markets were consistent with good reliability, given the resolving power afforded by the sample size. Whether this level of reliability would persist for longer, multi-year, horizons relevant to climate change cannot be known without running markets on such timescales, something that we strongly advocate.