Lobbying for Prediction Markets

Today I first appear in Science as an author (last time I was news), though I have eighteen coauthors.  It is a Prediction Markets "Policy Forum" (ungated here): 

Prediction market prices can be used to increase the accuracy of poll-based forecasts of election outcomes, official corporate experts’ forecasts of printer sales, and statistical weather forecasts used by the National Weather Service.

Several researchers emphasize the potential of prediction markets to improve decisions. The range of applications is virtually limitless – from helping businesses make better investment decisions to helping governments make better fiscal and monetary policy decisions.

Prediction markets have been used by decision-makers in the U.S. Department of Defense, the health care industry, and multibillion-dollar corporations such as Eli Lilly, General Electric, Google, France Telecom, Hewlett-Packard, IBM, Intel, Microsoft, Siemens, and Yahoo. The prices in these markets reflect employees’ expectations about the likelihood of a homeland security threat, the nationwide extent of a flu outbreak, the success of a new drug treatment, the sales revenue from an existing product, the timing of a new product launch, and the quality of a recently introduced software program.

These markets could assist private firms and public institutions in managing economic risks, such as declines in consumer demand, and social risks, such as flu outbreaks and environmental disasters, more efficiently.

Unfortunately, however, current federal and state laws limiting gambling create significant barriers to the establishment of vibrant, liquid prediction markets in the United States. We believe that regulators should lower these barriers by creating a legal safe harbor for specified types of small stakes markets, stimulating innovation in both their design and their use.

Coincidentally, on May 1 the CFTC asked for public commentary on regulating prediction markets – comments due July 7.

Should-not-be-needed disclaimer:  Such an endorsement says only that I estimate this change to improve on the status quo. 

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  • Robin,

    Congrats on getting some serious attention on this – much deserved. For a more rounded view, I’d love to read a post entitled:

    The Potential Negative Aspects Of Using Prediction Markets To Decide Policy

  • burger flipper

    A few months back EY mentioned that those who wish to deride future markets should quit talking and start taking the free money. I provided a pointer, in the comments, to a poker pro who was doing just that, to the tune of about 20k.

    Goofily enough, that lead to or influenced this NY Times story:

    Now that the primaries are realistically over, Ravitch/Adanthar reflects on the experience so far:

  • Silas

    Should-not-be-needed disclaimer: Such an endorsement says only that I estimate this change to improve on the status quo.

    As opposed to … ? What were you refuting here?

    Also, I’m guessing you’re going to share with the CFTC a little of your opinion?

  • I was surprised by the (admittedly) modest scope of the proposed changes. From the paper:

    “We suggest that three types of entities be eligible for safe harbor treatment. The first would be not-for-profit research institutions, including universities, colleges, and think tanks wishing to operate exchanges similar to the Iowa Electronic Markets. The second would be government agencies seeking to do research similar to that of nongovernmental research institutions. The third group would consist of private businesses and not-for-profits that are not primarily engaged in research, which would only be allowed to operate internal prediction markets with their employees or contractors.

    “In all cases, markets would be limited to small-stakes contracts. Although the definition of small stakes is somewhat arbitrary, we use the term to mean an exchange in which the total amount of capital deposited by any one participant may not exceed some modest sum, perhaps something like $2000 per year.

    “For its part, the CFTC should allow contracts that price any economically meaningful event. This definition could allow for contracts on political events, environmental risks, or economic indicators, such as those offered by the Iowa Electronic Markets, but would presumably not include contracts on the outcomes of sports events.”

    My concern is that the small stakes limit of $2000, the limits on who can operate markets, and the limitations on the scope of markets, will lead to spotty coverage which will preclude a robust evaluation of the merits of prediction markets in general. After all we have intrade.com already which provides spotty coverage of a number of issues – how much more will this add?

    Maybe “gambling can save science” but I don’t see how these steps would show it.

  • MKA

    Particularly when it comes to political elections, prediction markets like those at Intrade are a potential source for pre-election revealed political preferences, as opposed to opinion polling (stated preferences). If the market transmits information efficiently, it may allow for in depth analysis of political events.

    Just for fun, I attempted to estimate the impact of the Reverend Wright controversy on the probability that Obama would become the Democrat’s nominee.

    See my results at: http://casualeconomist.blogspot.com/2008/05/intrade-prices-and-barak-obama.html

  • Since Intrade is now relatively difficult to fund for US citizens, I think such a no-action or safe harbor policy would be tremendously positive. Also, there is nothing in the proposal that would preclude contracts that might be recognized as prediction markets being hosted as fully-regulated DCMs.

    In January 2007 the Chief Economist of the CFTC said the no-action option was off the table. Hopefully, that no doesn’t now reflect the agency’s policy. In any case, the small-stakes and no advertising limitations would mitigate the chances of a no-action exchange being interfered with by aggressive prosecutors. Safe harbor would be more robust in that respect.

    Now, I don’t think that a regulated DCM could host a science research claim because its outcome would theoretically be under the control of a single trader/researcher, i.e. it wouldn’t match the definition of an “excluded commodity”.

  • Hal and Silas, endorsing this proposal does not mean that I would not prefer other proposals; it just means I prefer this to the status quo. Chris Masse is an example of someone who has difficulty accepting this endorsement concept.