Economists Petition on Prediction Markets

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Statement on Prediction Markets – (Click here to read the abstract and download the petition from the SSRN site) – by Kenneth J. Arrow, Robert Forsythe, Michael Gorham, Robert Hahn, Robin Hanson, Daniel Kahneman, John O. Ledyard, Saul Levmore, Robert Litan, Paul Milgrom, Forrest D. Nelson, George R. Neumann, Charles R. Plott, Thomas C. Schelling, Robert J. Shiller, Vernon L. Smith, Erik Snowberg, Cass R. Sunstein, Paul C. Tetlock, Philip E. Tetlock, Hal R. Varian, Marco Ottaviani, Justin Wolfers, and Eric Zitzewitz – 2007-05-XX

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Executive Summary

Prediction markets are markets for contracts that yield payments based on the outcome of an uncertain future event, such as a presidential election. Using these markets as forecasting tools could substantially improve decision making in the private and public sectors. We argue that U.S. regulators should lower barriers to the creation and design of prediction markets by creating a safe harbor for certain types of small stakes markets. We believe our proposed change has the potential to stimulate innovation in the design and use of prediction markets throughout the economy, and in the process to provide information that will benefit the private sector and government alike.

Introduction

Prediction markets are markets for contracts that yield payments based on the outcome of an uncertain future event, such as a presidential election, the release date for new software, or the action taken by the Federal Reserve on short-term interest rates. A key benefit is that the market price of these contracts can potentially provide more accurate forecasts of future events than other methods. Using these markets as forecasting tools could substantially improve decision making in the private and public sectors. They also can help manage risk more efficiently. It is precisely because prediction markets have great potential that we think the government should facilitate rather than hinder the introduction of these markets.

There are significant regulatory barriers to establishing prediction markets in the United States, in part because they are potentially subject to gambling laws. We argue that U.S. regulators should lower barriers to the creation and design of prediction markets by creating a safe harbor for certain types of small stakes markets. We believe our proposed change has the potential to stimulate innovation in the design and use of prediction markets throughout the economy, and in the process to provide information that will benefit the private sector and government alike.

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Conclusion

We believe prediction markets can significantly improve decision making in both the private and public sectors. One of the clear benefits of allowing small stakes, non-profit markets to operate would be the greater use of prediction markets to inform both public and private decision making. A second benefit would be that access to better information could promote greater transparency and accountability in decision making. A third benefit might be that other countries and regions would promote prediction markets with more sensible regulation. Finally, we think there would be benefits from the development of new knowledge on how to design prediction markets.

We are aware that Congress did not intend the CFTC to regulate gambling and we believe that it is important to design this safe harbor in such a fashion that socially valuable prediction markets can get in, but gambling markets cannot.

Prediction markets have great potential for improving economic welfare and the decisions of private and public institutions alike. To help achieve that potential, the regulatory impediments to the use of prediction markets in the U.S. should be lowered. Here, we have suggested one approach for reducing those regulatory barriers.

AEI-Brookings Joint Center – The views in this paper represent those of the authors and do not necessarily represent the views of the institutions with which they are affiliated.

Kenneth J. Arrow – Stanford University

Robert Forsythe – University of South Florida

Michael Gorham – Illinois Institute of Technology

Robert Hahn – AEI-Brookings Joint Center

Robin Hanson – George Mason University

Daniel Kahneman – Princeton University

John O. Ledyard – California Institute of Technology

Saul Levmore – University of Chicago

Robert Litan – AEI-Brookings Joint Center

Paul Milgrom – Stanford University

Forrest D. Nelson – University of Iowa

George R. Neumann – University of Iowa

Charles R. Plott – California Institute of Technology

Thomas C. Schelling – University of Maryland

Robert J. Shiller – Yale University

Vernon L. Smith – George Mason University

Erik Snowberg – Stanford University

Cass R. Sunstein – University of Chicago

Paul C. Tetlock – University of Texas at Austin

Philip E. Tetlock – University of California at Berkeley

Hal R. Varian – University of California at Berkeley

Marco Ottaviani – London Business School

Justin Wolfers – University of Pennsylvania

Eric Zitzewitz – Stanford University

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Previous: Statement on Prediction Marketsby Robert Hahn – 2007-05-07

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9 thoughts on “Economists Petition on Prediction Markets

  1. Michael Strong said:

    This is great news!

  2. Alex Forshaw said:

    A start is a start.

    But why “not for profit”???

    Liquidity is an economy of scale. It requires a lot of investment before it begins to show results. You don’t encourage people to put in that kind of work without the possibility of handsome rewards. Nobody is going to toil away, building market infrastructure, providing tech support, advertising their market to expand their trader base and so on, when profit is basically banned.

    This is the entire problem with IEM. Their noble little “small stakes, not for profit” enterprise has crappy predictive power compared to BF and Intrade, whose liquidity still sucks, but at least the for-profits have enough pooled money to add SOME value.

    Again: prediction markets are good at aggregating complex, diffuse information. But no individual is going to go through the work of aggregating complex, diffuse information unless s/he’s rewarded for that work. IEM’s ivory-tower, profit-is-bad approach basically slams the door to aggregating any information worth more than the size of the deposit.

    The IEM approach is not workable. It will give birth to a lot of tiny pools of capital which will not reward information discovery. Then, the next group of people that wants to expand the scope of prediction markets will have to justify the subperformance of the IEM model, on top of all the other idiotic “protect the dumb little guy, to hell with innovation” excuses that have strangled PMs in the United States thus far.

    I “guess” this is better than nothing, but it’s infuriating nonetheless.

  3. Alex Forshaw said:

    And “internal” prediction markets for employees only?

    We have already talked about why that doesn’t work. Internal PMs are fashion statements by companies that want to look edgy and on the bleeding edge, but they never amount to much, because a company ALREADY functions as a prediction market by its existence: it aggregates information from participants and pays them for it. Unless the company is a colossus with huge separation between management and employees (in other words, inefficient), internal PMs are redundant 90% of the time.

    The point of a public PM is that an individual company knows it’s not omniscient, so it entices anonymous _outsiders_ to bring their information to the table, as well. Aggregating information is the *job* of the company’s employees.

  4. Alex Forshaw said:

    P.S.: In comment #2, I should have said that liquidity is an economy of scale after a certain point. It has a J-curve. You need a lot of participants before the curve winds back into positive (= “socially useful”) territory. Internal PMs are redundant for all but the biggest companies.

  5. Chris. F. Masse said:

    QUOTE But why “not for profit”??? UNQUOTE

    As you said, this is a start, in their views.

    I agree with you on the public prediction markets, but not on the corporate prediction markets.

  6. Jason Ruspini said:

    When I saw this I thought the “to” and “from” fields were more important than the exact text, which is mainly a conversation-starter. As Bo points out, the most important thing to do is to fill-in the “to” field.

    The statement does not seem to be directed at the CFTC since they are already familar with the arguments and have already ruled-out a no-action decision, though it might re-open a conversation.

  7. Alex Forshaw said:

    Yeah… I’m just playing the bitchy idealist/ devil’s advocate here.

    But if I thought IEM was worth my time, I could have finagled my way into it, probably. It’s easier to end-run around the whole bureaucratic morass and go to a sensibly liberalized exchange. I think you will see a lot of little “not for profit” prediction markets that will asphyxiate due to stifling of personal and managerial incentives.

    Making a case to a bunch of self-important regulators is hard enough without having to justify prior failures.

  8. Chris. F. Masse said:

    I got your point, Alex.

    Iowa Electronic Markets (IEM) is a bad US monopoly on political event derivatives / prediction markets.

    http://www.midasoracle.org/200…..n-markets/

    Jason Ruspini and Bo Cowgill’s takes are pertinent.

    Bo Cowgill’s comment:

    http://www.midasoracle.org/200…..ment-15556

    I would favor a “Creative Commons” license for this kind of petition, next time.

    Economists Speak Out on Prediction Markets

    by Steven D. Levitt on 08 May 2007

    http://www.freakonomics.com/bl…..n-markets/

    Steve Levitt of Freakonomics: I WON’T SIGN YOUR PETITION, BOB.

    http://www.midasoracle.org/200…..ition-bob/

    Chris Masse’s comment on the Freakonomics blog post about the legality of US prediction markets

    http://www.midasoracle.org/200…..n-markets/

    PREDICTION MARKET PETITION: Robin Hanson vs. Steve Levitt

    http://www.midasoracle.org/200…..ve-levitt/

    The limitations of logic (and the need for passion)

    http://www.midasoracle.org/200…..r-passion/

    Safe Harbor Letter too Timid – by Chris Hibbert

    http://www.midasoracle.org/200…..-big-wins/

    Bob Hahn turns the PETITION into a CONSENSUS.

    http://www.midasoracle.org/200…..consensus/

    Squawk on Prediction Markets – by Tom W. Bell

    http://www.midasoracle.org/200…..n-markets/

    Should AEI-Brookings have allowed Midas Oracle to re-publish the text of the economists’ petition on prediction markets?

    http://www.midasoracle.org/200…..n-markets/

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