Chapter 2 Quiz

Test your knowledge of prediction market history. Each question has one correct answer unless stated otherwise. Answers are hidden below each question — try to answer before revealing them.

Question 1

What year were the Iowa Electronic Markets (IEM) founded?

Show Answer **1988.** The IEM was founded by Robert Forsythe, Forrest Nelson, George Neumann, and Jack Wright at the University of Iowa's Tippie College of Business. The first market was on the 1988 presidential election between George H.W. Bush and Michael Dukakis.

Question 2

What regulatory instrument did the IEM use to operate legally within the United States?

Show Answer **A no-action letter from the CFTC.** This letter stated that the CFTC would not take enforcement action against the IEM, provided it remained a small-scale academic research project with limited investment amounts (originally capped at $500 per participant).

Question 3

In the Berg et al. (2004) study, how often did the IEM outperform contemporaneous polls in head-to-head comparisons of election prediction accuracy?

Show Answer **74% of the time.** In 596 comparisons between IEM predictions and polls conducted at the same time, the IEM was closer to the final outcome in approximately 74% of cases.

Question 4

What was the name of DARPA's proposed prediction market project, and in what year was it canceled?

Show Answer **FutureMAP (Futures Markets Applied to Prediction), canceled in 2003.** The specific market component was called the Policy Analysis Market (PAM). It was canceled within 24 hours of a press conference by Senators Ron Wyden and Byron Dorgan.

Question 5

Which economist proposed the concept of "idea futures" and developed the logarithmic market scoring rule (LMSR)?

Show Answer **Robin Hanson**, an economist at George Mason University. He proposed idea futures in the early 1990s and published the LMSR in 2003. The LMSR became the standard automated market maker for prediction markets.

Question 6

What was the Hollywood Stock Exchange (HSX), and why was it significant for prediction market history?

Show Answer **HSX was a play-money prediction market launched in 1996** where users traded virtual shares in movies and movie stars. It was significant because it demonstrated that play-money markets could produce accurate forecasts (its box office predictions rivaled professional analysts), attracted a mass audience (hundreds of thousands of users), and showed that financial stakes were not strictly necessary for accurate information aggregation.

Question 7

What country was InTrade based in, and why was this significant for its operations?

Show Answer **Ireland (Dublin).** This was significant because Irish law permitted licensed betting operations, allowing InTrade to operate legally under Irish regulation. InTrade argued that its Irish jurisdiction placed it beyond the reach of U.S. regulators, though this argument was never definitively tested in court. The CFTC ultimately took enforcement action against InTrade in 2012.

Question 8

What specific event in 2013 led to InTrade's closure?

Show Answer **InTrade suspended trading on March 10, 2013, citing "possible financial irregularities."** Investigation revealed that customer funds had been commingled with operating funds and some money had been used for unauthorized purposes. The company was placed into liquidation, and customers recovered only a fraction of their deposits. Founder John Delaney had died in 2011 while climbing Mount Everest.

Question 9

What is the significance of the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) for prediction markets?

Show Answer **Dodd-Frank gave the CFTC explicit authority to regulate event contracts** and empowered the agency to block contracts involving "activity unlawful under any Federal or State law," including contracts on terrorism, assassination, and war. This provision — directly inspired by the FutureMAP controversy — provided the legal basis for subsequent CFTC actions against prediction market platforms.

Question 10

What distinguished Augur from all prior prediction markets when it launched in 2018?

Show Answer **Augur was the first decentralized prediction market built on a blockchain (Ethereum).** Unlike centralized platforms such as InTrade, Augur was a protocol — a set of smart contracts — with no central operator. This made it theoretically censorship-resistant and trustless (smart contracts automatically settled bets). However, Augur v1 suffered from high gas fees, poor user experience, and thin liquidity.

Question 11

What is a "Designated Contract Market" (DCM), and which prediction market platform was the first to receive this designation?

Show Answer **A DCM is a CFTC-regulated exchange authorized to list and trade futures and options contracts in the United States.** Kalshi was the first prediction market to receive DCM designation, in November 2020. This allowed Kalshi to legally offer event contracts to U.S. residents under full CFTC oversight.

Question 12

What was Philip Tetlock's key finding in Expert Political Judgment (2005), and how did it relate to prediction markets?

Show Answer **Tetlock found that experts were, on average, only slightly better than chance at predicting geopolitical events** — and worse than simple statistical models. This devastating finding for pundit forecasting opened the door for prediction markets and structured forecasting methods as alternatives. Tetlock later co-founded the Good Judgment Project, which demonstrated that ordinary volunteers using structured methods could outperform intelligence analysts.

Question 13

What did the "superforecasters" in the Good Judgment Project achieve relative to intelligence analysts?

Show Answer **The GJP's best forecasters consistently outperformed intelligence analysts who had access to classified information.** The GJP's aggregation methods produced forecasts approximately 30% more accurate than those of the intelligence community. This was funded by IARPA (the intelligence community's research arm), which had taken up work related to prediction markets after DARPA's FutureMAP project was canceled.

Question 14

What Friedrich Hayek paper (1945) is considered foundational to the theoretical justification for prediction markets, and what was its central argument?

Show Answer **"The Use of Knowledge in Society" (1945).** Hayek argued that no single individual or central planner can possess all the dispersed knowledge in an economy. Markets solve this problem by using prices to aggregate and convey information held by millions of individuals. Prediction markets are a direct application of this principle — using prices to aggregate dispersed knowledge about future events.

Question 15

What was the approximate trading volume on Polymarket's 2024 U.S. presidential election market?

Show Answer **Over $1 billion in cumulative trading volume.** This was an unprecedented figure for a prediction market and represented the mainstream arrival of prediction markets in electoral politics.

Question 16

In what year did the CFTC settle with Polymarket, and what was the outcome?

Show Answer **January 2022.** The CFTC imposed a **$1.4 million fine** on Polymarket for operating an illegal unregistered trading platform. Polymarket subsequently blocked U.S. users from its platform, though enforcement of this restriction was imperfect.

Question 17

What is the term for the governance system proposed by Robin Hanson in which prediction markets are used to evaluate policy proposals?

Show Answer **Futarchy.** Under futarchy, elected officials would define national goals (values), and prediction markets would determine which policies are most likely to achieve those goals (beliefs). The concept was articulated in Hanson's 2007 paper "Shall We Vote on Values, But Bet on Beliefs?"

Question 18

According to Charles Manski's 2006 critique, why can't prediction market prices always be interpreted as probabilities?

Show Answer **Because the mapping between prices and true probabilities depends on participants' risk preferences.** If market participants are risk-averse, risk-neutral, or risk-seeking, the same true probability will produce different market prices. Only under the specific assumption of risk-neutral participants (or certain other special conditions) do market prices exactly equal probabilities. The practical significance of this critique is debated.

Question 19

What letter published in Science in 2008 called for the legal barriers to prediction markets to be lowered, and who were some of its notable signatories?

Show Answer **"The Promise of Prediction Markets."** Notable signatories included Nobel laureates **Kenneth Arrow, Vernon Smith, and Robert Shiller**, along with prominent economists and researchers such as Robin Hanson, Justin Wolfers, Eric Zitzewitz, Cass Sunstein, Hal Varian, Paul Milgrom, and Philip Tetlock (among many others). The letter argued that prediction markets were a valuable social institution being held back by outdated gambling regulations.

Question 20

What is the "favorite-longshot bias" in prediction markets?

Show Answer **The favorite-longshot bias is the tendency for prediction markets to overweight the chances of the favored outcome (favorite) and underweight the chances of unlikely outcomes (longshots).** In the IEM context, this manifested as a tendency to overvalue the leading candidate's contracts. This bias has been documented in both prediction markets and traditional betting markets (particularly horse racing).

Question 21

Manifold Markets uses a virtual currency called "mana." What key innovation did Manifold introduce regarding market creation?

Show Answer **Frictionless market creation.** Any user can create a market on any question in seconds, with no approval process. This led to an explosion of niche and creative markets covering everything from geopolitics to personal bets, generating a far wider range of forecasting questions than any prior platform.

Question 22

What were the two main reasons the 19th-century U.S. political betting markets declined by the mid-20th century?

Show Answer **1. The rise of scientific polling**, beginning with George Gallup's successful prediction of the 1936 presidential election, provided a legal alternative for election forecasting. **2. The gradual expansion of anti-gambling laws** made organized political betting increasingly risky from a legal standpoint.

Question 23

What landmark court ruling in 2024 affected Kalshi's ability to list political event contracts?

Show Answer **In September 2024, a federal judge ruled in Kalshi's favor**, finding that the CFTC had exceeded its authority in blocking Kalshi from listing congressional election contracts. The CFTC's emergency stay was denied, and Kalshi began listing political event contracts. This was a landmark regulatory moment that potentially opened the door to broad, legal, regulated prediction market trading on political events in the United States.

Question 24

What did the InTrade market on Saddam Hussein's capture in December 2003 reveal about prediction markets?

Show Answer **The contract price spiked dramatically on the afternoon of December 13, 2003 — hours before the official announcement of Hussein's capture.** This was cited as evidence of two things: (1) the market's remarkable speed in processing information from well-connected participants, and (2) the risk of insider trading on prediction markets, since some traders apparently had advance knowledge of the capture.

Question 25

Name three distinct models (approaches) for prediction markets that coexist in the current ecosystem, with one example platform for each.

Show Answer 1. **Regulated real-money exchange**: Kalshi (CFTC-designated contract market) 2. **Cryptocurrency/blockchain-based market**: Polymarket (built on Polygon, settles in USDC) 3. **Play-money market**: Manifold Markets (uses virtual currency "mana") Additional valid answers include: 4. **Academic real-money market**: Iowa Electronic Markets (IEM) 5. **Reputation-based forecasting platform**: Metaculus (no money at stake; reputation scores as incentives)

Scoring Guide

  • 22-25 correct: Excellent — you have a thorough understanding of prediction market history.
  • 18-21 correct: Good — you grasp the major themes with some gaps in detail.
  • 14-17 correct: Satisfactory — review the sections where you missed questions.
  • Below 14: Re-read the chapter and focus on the summary tables and key milestones.

This quiz accompanies Chapter 2: A Brief History of Prediction Markets.