How Prediction Markets Work

The above graph shows the prices of contracts traded on the Iowa futures market (legally sanctioned for educational purposes).  The contracts pay out a dollar if the event occurs, so the prices can be interpreted as the probability of the underlying event.

The graph above, taken on Tuesday 2pm of Election day shows that a contract that pays out if the Democrats control the House and the Republicans control Senate is trading at about $0.70 (plotted in black), indicating a 70% chance that this will occur.

A contract that pays out if the Republicans control both House and the Senate is trading at about $0.17 (plotted in red), indicating a 17% chance that this will occur.

Prediction markets are being used by private companies, like Best Buy:

TagTrade accurately predicted the delay or on-time schedule of major initiatives including new services, IT initiatives, and store openings. Additionally, the Best Buy TagTrade market proved to be more accurate than traditional forecasts, and in some cases 5% more accurate in predicting sales forecasts, such as media sales during the quarter.

Prediction markets claim to be more accurate than other forecasting methodologies (like polls), and are best used for:

...forecasts used for New Product Introductions (NPI) and longer-term capacity requirements planning.