CFTC Event Market Comment

In May the US CFTC declared that it was considering offering more legal approval for "markets commonly referred to as event, prediction, or information markets."  They requested comments, due by today.  My comment concludes:

In addition to existing regulatory regimes for ownership-hedging securities, idiosyncratic-risk-hedging insurance, and common-risk-hedging futures, it could make sense to have a distinct regulatory regime for markets whose main reason to exist is the info that they collect.  Compared with existing commodities futures regulation, such a regime should set a much lower barrier to creating such markets, as much of the social value may be distributed in millions of small markets.  And while it is hard to determine in general which markets would create high social info value, relative to cost, we should presume such high value when a sponsor is willing to pay to ensure that traders suffer no average financial cost from their participation.

Added:  I’m off in a few hours for a two week trip to Helsinki and then Oxford.  I have posts ready for while I’m gone, but I expect to comment less often. 

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  • Aren’t there agglomeration economies that would make a few large prediction markets more valuable than thousands of smaller ones? Also, wouldn’t the ideal situation be to have markets below a certain threshold be unregulated by the government altogether?

  • The website with the call for comments says:

    The House Committee on Agriculture stressed that contracts that could be expected to be used almost entirely for speculation would be against the public interest. H.R. Rep. No. 975, 93 Cong., 2d Sess. 29 (1974).

    What is the justification for saying that speculation is against the public interest?

  • Are the “excluded commodities” referred to in Section 1a(13) of the Commodity Exchange Act given the exceptions described in Section 4(c)(1) of the Act to “promote responsible economic or financial innovation and fair competition” by exempting them from the provisions of the Act? In other words, do “exempt” and “excluded” refer to the same thing?

    It is difficult to give advice to an agency on futures markets that has to take as given that gambling on the outcome of football games or celebrity marriages is socially harmful. My instinct is to answer questions about social benefit by saying that any activity people voluntarily engage in, that doesn’t harm other people, must have net social benefit. But that would imply that a lot of illegal things should be legal. Specifically, the agency is asking whether to classify C as being A, which is illegal; or B, which is not; my answer, that both A and B should be legal, is unhelpful, and in this context would be harmful.

    Historically, why is gambling illegal, and why are exceptions made for racetracks and state lotteries? How much social harm was actually caused by gambling, that is not caused by racetrack and lotto today?

  • On my view, “information markets” (a puzzling name, since every market price is the product of information) provide a valuable source of information when their query is of when rather than whether an event will occur.

  • TGGP

    In your comment you hold wishful thinking responsible for the belief that non-profits will behave differently than for-profit organizations. It may not be relevant, but there is evidence that they really do behave differently.

  • Nicholas, for markets on the same topic there are indeed substantial scale economics. Such effects are much weaker for markets on different topics.

    Phil, while it might be more difficult to advise an agency that has to accept generic gambling as socially harmful, this is in fact the situation the CFTC is in.

    TGGP, there is a large literature on the non-profit and for-profit differences. Don’t be misled by a single study.

  • I submitted this comment. The numbers refer to specific questions in the RFC.

    12. What objective and readily identifiable factors, statutorily based or otherwise, could be used to distinguish event contracts that could appropriately be traded under Commission oversight from transactions that may be viewed as the functional equivalent of gambling?

    Here are some criteria that may be sufficient, though not necessary, to discriminate an event contract generating a social value, from gambling:

    • A sponsor creates the market on which the contract is traded at no cost to participants, including transaction costs or asymmetric odds (biased towards “the house”); or a non-profit entity creates the market. [Stolen from Robin.]
    • The event has economic significance.
    • Learning to predict the event has positive social benefits, or trains participants in useful skills: For example, learning to predict eclipses led to the development of astronomy and of science in general. Learning to predict which rulings will be struck down by the Supreme Court trains people in legal reasoning.
    • The creation of the market creates incentives for those people whose actions will determine the outcome, to take steps that have social benefit. For example, a market for predicting which accounting firm would be the next to be indicted or convicted, would motivate executives of those firms to implement programs to ensure compliance with the law.
    • In general, an event contract whose trading value influences the actions of people who control the outcome of the event, is likely to have social value, since in general companies are motivated to appear to act in socially-approved ways.

    18. Is the issuance of staff no-action relief, such as the relief issued to the IEM, an appropriate or preferable means for establishing regulatory certainty for event contracts and markets? Is a policy statement appropriate or preferable?

    No. While this is sufficient to enable experimental markets such as the IEM, we need a mechanism to enable the creation and monitoring of large, billion-dollar markets in order to gain significant social benefits from them. The IEM is an experimental market, whose purpose was to bring us to the point we are at today. The next step is to create real markets.

  • Don’t miss Cafe Kappelli while you’re in Helsinki.

  • Robin Brandt

    If you need a local quide or help with anything contact me. Maybe we could even organize a small OB Meetup, there are at least 3 people in Helsinki following OB.

  • What I think of Robin Hansons comment to the CFTC and what I think about his slam at TradeSports-InTrade, BetFair-TradeFair, and HedgeStreet.

    Overall, his input is very brainy.
    Its a major contribution to the general discussion about prediction markets.

    Please, allow me to disagree on one thing he said.

    Robin Hanson:
    One proposed distinguishing criteria includes the size of an ind…

  • Robin Hansons purity test is based on an absurd principle.

    Its not the motivation that is important to assess its the liquidity that counts. The more trades, the better. Liquidity leads to statistically accurate probabilities predictions. Liquidity, liquidity, liquidity, doc.

    Robin Hanso…

  • @Robin Hanson: Michael F. Martin would be referring to CafĂ© Kappeli.

    There’s probably a lot more people in and near Helsinki following OB at least semi-regularly. Anyway, a meetup would be great, if you have time for it.