Betting the Weather

Pennsylvania State University has set up a prediction market for the weather, letting two groups of students bet against professional forecasting services like AccuWeather in trying to predict the temperature in different locations. “To date, the weather markets have been as accurate as the major public forecasting services,” says the Penn State press release, which is printed below in its entirety.

The market’s predictions have been off by “only 6.6 percent,” which doesn’t sound so great to me, but I guess that says something about the difficulty of predicting the weather. The press release also notes that traders who are studying meteorology do better than traders who are studying business.

Which makes me wonder if the story here is simply that the typical Penn State meteorology student is as good a forecaster as the typical AccuWeather meteorologist. I wouldn’t be too surprised: the national weather map that’s published every day in the N.Y. Times is supplied by … Penn State.

Penn State Researchers Testing Futures Markets For Weather Forecasting

UNIVERSITY PARK, PA (March 21, 2007) – Economists at Penn State’s Smeal College of Business and College of Earth and Mineral Sciences are testing whether futures markets can be used to accurately forecast the weather, and, so far, they’ve found the markets to be just as accurate as major forecasting services.

The 60 participants in this predictions market experiment, which is in the midst of a two-year run at Smeal’s Laboratory for Economics Management and Auctions, are mostly students studying business or meteorology at Penn state. They use allotted funds to bet on what they believe the high and low temperatures will be in different U.S. cities on a given day. As the going rates for various temperatures fluctuate within the market, the researchers can weigh the market’s confidence in what temperatures will be reached.

To date, the weather markets have been as accurate as the major public forecasting services that serve as benchmarks for the research: AccuWeather, the BBC, CNN, and the National Weather Service. On average, the temperatures predicted by the markets have been off by only about 6.6 percent.

In addition, the results so far show the market to be far more profitable for traders who are studying meteorology than those who are studying business. This is consistent with economic and financial models that suggest that better informed traders can reap substantial profits from their inside information.

“Investors, political pundits, and sports fans have all used futures markets to successfully predict everything from presidential elections to World Series champions,” said Anthony Kwasnica, associate professor of business economics at Smeal. “Our experiment is along those same lines. By using markets to forecast something as unpredictable as the weather, we’re testing the limitations of futures markets.”

Each participant in the experiment, which is funded by the National Science Foundation, has the opportunity to buy and sell contracts that represent a particular temperature range. For instance, the markets for March 8 were focused on Tucson, Ariz., and participants could buy or sell contracts betting on a high temperature of 74 degrees or less, 75 to 76 degrees, 77 to 78 degrees, 79 to 80 degrees, 81 to 82 degrees, or 83 degrees or more.

Each contract represents a commitment by the seller to pay the buyer $1 if the temperature falls within the specified range of the contract. Participants can base their decisions to buy or sell contracts on any information available to them, including weather forecasts.

In the Tucson example, if a participant thinks that the high temperature will be 81 degrees on March 8, he offers to buy an 81- to 82-degree contract for a price of up to $1, which he determines based on his level of confidence in his prediction. A seller can then accept or reject the offer.

If the offer is accepted and 81 degrees is indeed the high temperature on record at the end of the day, then the seller of the contract pays the buyer $1. Thus, the seller loses and buyer gains the difference between $1 and what he paid for the contract.

If the high temperature is outside of the 81- to 82-degree window, then the buyer loses what he paid to the seller for the contract and the seller wins.

The going price of the contracts, which are listed on a Web site run by LEMA, determines the market’s confidence in the likelihood of a particular high or low temperature being recorded -? a high price on a particular temperature reflects a high degree of confidence that the temperature estimate will be accurate. Thus, the markets can provide a measure of uncertainty associated with the prediction, something not typically provided by weather forecasters.

The cities and dates chosen for the experiment follow those used in the WxChallenge, a weather forecasting competition developed at the University of Oklahoma. The market’s forecasting accuracy will ultimately be judged in comparison to the accuracy of the forecasters participating in the WxChallenge. So far, the predictions markets are just as accurate as the WxChallenge consensus forecast.

In addition to Kwasnica, the Penn State researchers leading this study are Gary Bolton, professor of business economics, Smeal College of Business, and Andrew Kleit, professor of energy and environmental economics, College of Earth and Mineral Sciences.

For more details on the weather predictions markets, visit lema.smeal.psu.edu/prediction.


jughead

I set up a similar tool for college students, economists and analysts to bet on economic indicators (www.financialnext.com).

Volume on the website is pretty low now, but I wonder if this type of "game" can be applied to any subject and what the difference in results would be across disciplines. How much does the complicatedness of the subject matter?

Nobrainer

For those interested in winning prizes in weather games (and are enrolled college students), bookmark degreetrade.com, from which I won a shiny new iPod Nano. The grand prize is usually a new plasma TV.

I suggest bookmarking it because it runs for only 3 weeks, once a year in the fall.

nphebel

First, I am a fan of prediction markets, but... The fact that this market is about as accurate as major public forecasters should come as no surprise -- all this market is really testing is whether college students can wake up in the morning and accurately read public forecasts from the web. They then form a bid-ask just around the forecasted numbers. Just because a prediction market mimics professional forecasting doesn't mean that it is equivalent in value to professional forecasting.

That being said, if the traders would develop a bias relative to forecasters and would beat them, that would be interesting. Also, the concept of teasing out uncertainty in a forecast also should have some value.

lermit

So this'd prove that there are actually people willing to bet against weather predictions? Murky!

.lermit

furiousball

What's the "I'll Gamble on Anything" factor for habitually addicted gamblers on this?

AdamRuby

AccuWeather was started by a Penn State grad and is based out of College Park PA.... (http://wwwa.accuweather.com/company.asp)...

smashingn

Weather forecasting is a tough business. The first weatherman, a British Victorian, committed suicide after getting his forecast wrong too often (he blamed himself).

yzrs

I agree with (3). However, the true value in a prediction market would be in getting an implied volatility number. I've always wished that the weather forecast would include a probability distribution around temp and precipitation (joint would be great!). High of 32 +/-2 is a lot different than High of 32 +/-30.

lermit

How popular is it among the weather-prediction community?

.lermit

Nobrainer

A couple points of interest:

Check out forecastadvisor.com to see how well the different forecasters operate.

It was only in reading through that site that I learned that forecasters consider themselves accurate with respect to high temperature forecasts if they're within +/-3 degrees.

In my short term research, I found that certain national forecasters, forecasting for certain locations seemed to show a predictable bias. This was based on the average temperature of 5-day forecasts. This raises the question, do some forecasters intentionally add or subtract a couple degrees from long term forecasts to placate their audience, or to perhaps induce tourism by making temperatures seem more comfortable?

David Peterson

Interesting, but I think that the biggest limitation here is that those who are participants do not have the ability to affect the outcome. I think that that's one of the reason why markets for elections work, because voters participate in the futures. At best this can weed out the most accurate weather services because I'm sure that is the best information that the participants can use for this.

T

Enron was trying to sell weather derivatives. I guess that business didn't do well enough to help them.

wxgurl

Also of note, I saw someone pointed out who started AccuWeather as well as it's location, but they forgot to mention that something like 85% of it's employees are Penn State grads.

nickwyeth

Even though weather prediction isn't necessarily the purpose of this market, it may be of interest that the Chicago Mercantile Exchange offers a variety of weather derivatives.

http://www.cme.com/trading/prd/weather/index14270.html

Kent

Stephen,

You are mistaken in labeling the weather exchange as a "prediction market." :-( In reality it is a "prognosis market" (aka "prognostic market" aka "P2P betting futures"). We need to be very careful about using terms carefully and consistently. :-) :-)

Kent

prometheus

This reminds me of how the CIA set up websites for people to bet on world events, which they assumed could somewhat accurately predict the future.

It didn't work.

dtashima

I went to grad school in meteorology, and there was an annual weather forecasting contest. Automatically entered in this contest were the NWS, as well as the average of all entries, which was labeled "Consensus".

Consensus consistently scored in the top 3 or 4 of 40 entries.

Of course, there were a few people that could consistently beat both the NWS and consensus, but they had a tremendous amount of knowledge and experience.

Dave

jughead

I set up a similar tool for college students, economists and analysts to bet on economic indicators (www.financialnext.com).

Volume on the website is pretty low now, but I wonder if this type of "game" can be applied to any subject and what the difference in results would be across disciplines. How much does the complicatedness of the subject matter?

Nobrainer

For those interested in winning prizes in weather games (and are enrolled college students), bookmark degreetrade.com, from which I won a shiny new iPod Nano. The grand prize is usually a new plasma TV.

I suggest bookmarking it because it runs for only 3 weeks, once a year in the fall.

nphebel

First, I am a fan of prediction markets, but... The fact that this market is about as accurate as major public forecasters should come as no surprise -- all this market is really testing is whether college students can wake up in the morning and accurately read public forecasts from the web. They then form a bid-ask just around the forecasted numbers. Just because a prediction market mimics professional forecasting doesn't mean that it is equivalent in value to professional forecasting.

That being said, if the traders would develop a bias relative to forecasters and would beat them, that would be interesting. Also, the concept of teasing out uncertainty in a forecast also should have some value.