WEB EXCLUSIVE: What Vernon Smith told the CFTC about the social utility of the event derivative markets —the so-called “prediction markets”

Chris F. Masse May 26th, 2008

Professor Vernon Smith (2002 Nobel Laureate, Economics) —PDF file:

1. On oversight: I suggest that initially this function be entirely limited to a monitoring and data archive function. Such information should be available for experimental, econometric, finance and other research scholars to study. If new regulatory rules governing rights to take action (”property rights”) are needed beyond those that emerge in the ordinary course of private institutional design for trading, let them evolve out of these research studies including examination by controlled testing in the laboratory. (Regulations controlling fraud, theft, deceiption, and so on already exist and would apply.) It was from experimental economics (in Iowa) that event contract trading first blossomed, and many ongoing research questions arise in dealing with contract design, event mesurement feasibility, etc. These are primarily empirical issues and the combination of field and experimental data made possible by the CFTC initiatives are of great importance.

2. Event markets do not constitute gambling. Gambling involves the deliberate creation of artificial zero-sum opportunities to engage in risk taking decisions that redistribute existing resources. Event contracts markets are in the class of variable-sum stock and derivatives’ markets in which information on the future outcome of productive and technological activities is dispersed, uncertain, and rendered valuable to society when aggregated into prices. The information priced in these markets enables actions to be taken that create wealth. Similarly, in event markets, better information made possible by trading event contracts produces social gains that make such activity wealth enhancing. Thus, if a futures market in Florida orange juice enables improved predictions of frost, better crop decisions enhance wealth creation and potential improvements in technology. Moreover, all these issues are important generators of testable hypotheses, which can help to inform both the extent to which they create social and economic value and whether new regulations are desirable.

3. Bear in mind that any limitation on the emergence of new market forms must necessarily run the risk of also limiting new forms of specialization and wealth creation. We need always to be open to such new possibilities.

THE MIDAS ORACLE TAKES:

- CALL TO ACTION: Let’s fight so that the CFTC allows the FOR-PROFIT prediction exchanges to deal with “event markets”.

- In the for-profit vs not-for-profit debate, our prediction market luminaries, doctored by Bob, are on the wrong side of the issue.

- COMMENTS TO THE CFTC: What to expect from Tom W. Bell and Jason Ruspini

- A young economist rebuts the American Enterprise Institute.

BACKGROUND INFO:

- CFTC’s Concept Release on the Appropriate Regulatory Treatment of Event Contracts… notably how they define “event markets”, how they are going to extend their “exemption” to other IEM-like prediction exchanges, and how they framed their questions to the public. Here are the comments sent to the CFTC.

- The Arnold & Porter lawyers explain the meaning of the CFTC’s concept release on “event markets”. — (PDF file)

- The Schulte & Roth & Zabel lawyers’ takes. — (PDF file)

- The Sullivan & Cromwell lawyers’ takes. — (PDF file)

- The American Enterprise Institute’s proposals to legalize the real-money prediction markets in the United States of America

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