July 4th 2008
The Commodity Futures Trading Commission
Three Lafayette Centre
1155 21st Street NW
Washington, DC 20581
U.S.A.

Attention: Office of the Secretariat

RE: “Concept Release on the Appropriate Regulatory Treatment of Event Contracts”

To Whom it May Concern:

It is an honour for me as Chief Executive Officer of Intrade the Prediction Market Limited (“Intrade”) to provide price discovery information on thousands of event markets free of charge to notable institutions such as yourselves at the U.S. Commodity Futures Trading Commission, the U.S. Navy, the Federal Reserve Banks of New York, Richmond, and Chicago, the European Central Bank, the Bank of Japan, the American Enterprise Institute – Brookings Joint Centre, CATO Institute, and the Bank of England. We have similarly supplied our price discovery event market information to political organisations, students and staff at every Ivy League College, and students and staff at over 50 universities worldwide.

We estimate that over 300 global media businesses such as The New York Times, The Wall Street Journal, The Washington Post, The Financial Times, The Los Angles Times, Chicago Tribune, Economist, Bloomberg, Reuters, Forbes, Time, Fortune, CNN, CNBC, Fox, ABC and others have used Intrade event market information.

Investment firms on Wall Street, and the other major financial centres of the world, have solicited and been provided with Intrade price discovery event market information. The above lists are not exhaustive.

Further, Intrade provides free real-time transparent price discovery event market information to millions of people from the general public. While Intrade serves a global community and has registered members from 162 countries, our 82,000 plus membership are predominantly resident in the United States. The predictive probability information on event markets that we supply to the general public is both intuitive and readily and rapidly assimilated without the necessity for paid subscriptions or a financial education.

Intrade has been transparent and industrious, as have others, in nurturing the development of the event market industry. Intrade as a profit-maximizing business does of course expect to significantly benefit from its dedicated employment. However the benefits to society at large will be equivalently great from Intrade’s focus on event markets.

While U.S. institutions and society benefit from Intrade’s services it is perversely unclear as to whether Intrade, and indeed myself, are considered persona gratis by the United States. However, we are more optimistic than ever that Intrade as the de facto leader in the event market industry sector will soon have the ability to stand on a firm, transparent and appropriate regulatory footing thanks to the process that the CFTC has accelerated through their request for comments on how to regulate event markets.

Not since the Industrial Revolution have the risks and their commensurate opportunities of dealing with great uncertainty and rapid change that we all face been so high. Much of this change and uncertainty is technology driven, with most countries, organizations and households accepting, in theory at least, that they must change.

The recent implosion of credit markets is just one example of the great uncertainty and potential for events impacting citizens of the United States and farther afield.

To adapt to a changing world in an orderly and optimal manner requires access to information, robust decision-making processes and the courage and determination to grasp the opportunities that a dynamic world offers. The CFTC and indeed the United States itself has access to the information, the decisionmaking expertise, and a historical track record of determination and accomplishment.

But the relentless change that we all face will be best dealt with if we have the best information, in real time, to reduce uncertainty, risk and stress. Event market information can and has increased the quality and timeliness of decision-making. Event markets can act as a democratic mechanism that gives voice to the broadest range of event stakeholders and, in so doing, aggregates a peerless information set. By encouraging the aggregation, distribution, validation and appropriate use of the best event market information, society will benefit even more than it does today from event markets. To do otherwise than to encourage event market development would be a societal travesty.

The dynamic nature of the world that we live in, where the pace and systematic impact of change seem to be increasing, will be greatly aided if event markets are given a certain regulatory footing in the United States and other jurisdictions. This, coupled with the fact that markets excel in aggregating information and estimating the value of a product or the likelihood of an event occurring, testifies to the logic that the price discovery that event markets produce should now be encouraged by the CFTC.

The CFTC by clarifying the status of event markets now will be of great service to Americans. In this regard the CFTC has an important opportunity and one that the CFTC seem very positively biased to grasp in light of its statements, such as…
- The CFTC state on their website that they have “An Important Mission in the Ever-Changing World of Finance.”
- “The CFTC assures the economic utility of the futures markets by encouraging their competitiveness and efficiency.”
- “The CFTC is also mandated to enable futures markets to serve the important function of providing a means for price discovery and offsetting price risk.”

CFTC Acting Chairman Walt Lukken, when announcing the execution of a memorandum of understanding with the SEC on March 11, 2008, stated: “The regulatory structure that oversees the U.S. financial markets embrace innovation, growth and competition in the global marketplace, without compromising market integrity, customer protection and the public good.”

The above statements, in addition to the Concept Release by the CFTC, are very encouraging. It is specifically this price discovery and risk management mandate that justify the CFTC’s embrace of event markets, should justification be needed.

Intrade has listed 211,607 individual event markets and aggregated and distributed predictive event market information on subjects such as Arctic Oil Drilling, Climate Change, Commodities, Company Earnings, Constitutional Referenda, Currencies, Disease Outbreaks, Earthquakes, Economic Numbers, Entertainment Awards and Earnings, Indices, Euro Adoption, Federal Reserve Announcements, Gas Prices, Gasoline Tax, Geo Political Events, Homeland Security in the U.S., Mergers & Acquisitions, Social Security Reform and U.S. Taxes. This list is far from exhaustive.

No other platform has listed more event markets than Intrade. To the best of our knowledge and belief the event market leadership position that is often ascribed to Intrade is wholly justified from a review of the breadth of the event markets listed and information we have aggregated and distributed. Information, as noted above, that is used by governmental agencies, businesses, academics, and the general public to reduce uncertainty and in so doing increase the speed and quality of decisions being made.

While the obvious benefits to the general public in terms of price discovery and decision-making of some Intrade event markets will be more obvious than others, we can make robust arguments that all have the potential to serve the dual purpose of price discovery and a mechanism for offsetting price risk.

The CFTC by clarifying its position on event markets will give all event market stakeholders valuable direction on market and participant eligibility. Whether used at the federal government level or by the individual citizen, event markets provide a magnificent opportunity to use price discovery information in managing economic risk. Here are just a few examples from the 211,607 event markets we have listed.

Intrade has listed markets on the probability of the Homeland Security alert level being above or below a certain level at a certain date. “The United States spends roughly $100 billion per year on homeland security” according to the White House. The costs of migrating from a threat level of “Guarded” to a threat level of “Elevated” have very significant costs for the government, business, and society. By utilizing event market price discovery information on the probability that the alert level will be at a certain threshold on a given date, the economic consequences of the threat level can be managed in a more insightful way.

Jason Ruspini has suggested markets to Intrade on whether the marginal personal income tax rate for single U.S. filers will be equal to or greater than a range of specified percentages for tax years 2009, 2010 and 2011. Having spoken directly to a number of tax paying citizens from the United States, the transparency of this information undoubtedly serves a public good. Is there a Unites States resident taxpayer who will read this comment who is not interested in the taxes she or he will pay next year?

On a more macro level, Intrade has listed a market on whether the cold fusion experiment of Dr. Yoshiaki Arata will be replicated in a peer-reviewed scientific journal before 31 December 2009. The possible impact of such a development to our energy needs little hyperbolae. The fact that President Bush requested $25 billion for the U.S. Department of Energy’s 2009 Budget speaks to the importance of maximum transparency in such matters. It may also be interesting to note that $493 million of the $25 billion was allocated to Fusion Energy Services. Does transparency to such price discovery information serve positively the United States and others? Absolutely!

Professor Koleman Strumpf suggested that Intrade list a market on whether Blu-Ray Disc sales will outnumber HD-DVD disc sales in the United States in 2008. If an organisation’s employees or profits are potentially influenced by the outcome of this event, as were Toshiba’s, the main supporter of HDDVD, then access to such information is both valuable and gives opportunity for welfare maximisation.

Intrade has also listed, at the request of University of Westminster Business School, markets on whether the number of violent crimes committed in 2010 will be lower than those committed in 2007. Intrade has additionally listed at the request of a United States resident member of our platform a market on the impact of U.S. Government debt if a non-Democrat is elected president of the United States in 2008.

Professor Eric Zitzewitz, Professor Robin Hanson, Professor Justin Wolfers and others at the forefront of event market academia have all suggested event markets to Intrade in the past that have been listed and which provided event market information both for academic study and business and general public use.

Imagine if you were a resident of a state such as Florida that is frequently exposed to severe storms and how crucial information on the likelihood of a storm hitting your state can be if your business, family and friends are likely to be impacted by such an occurrence. Intrade lists event markets on such
eventualities.

The event markets listed on Intrade provide price discovery information on whether an earthquake measuring 9.0 or more on the Richter Scale will happen anywhere in the world in 2008; whether Avian Flu H5N1 is confirmed in the United States in 2008; whether the U.S. carries out an overt attack on North Korea; or even whether Robert Mugabe departs his presidency in 2008. These significant events are highly relevant to millions of people in the United States and elsewhere.

President Bush stated in an address on global climate change that: “This is a challenge that requires a 100 percent effort; ours, and the rest of the world’s.” It seems to us impossible to make a “100 percent effort” to address the challenge of climate change without using event markets to aggregate information, such as that provided by Intrade’s market on whether 2008 will be one of the warmest years ever recorded.

All of the markets cited above give information on the probability of the event occurring. Some of the information aggregated and distributed by Intrade has been more predictive than other. The predictive accuracy of Intrade’s event markets and event markets generally have been cited and studied extensively by academics and others including, but not limited to Professor Robin Hanson, Professor Charles Noussair, Professor David Paton, Professor Leighton Vaughan Williams, Dr. David Pennock, Professor Eric Zitzewitz, Professor Mark Perry, Professor Erik Snowberg, Professor Marco Ottaviani, Professor Justin Wolfers, Professor Koleman Strumpf, and Professor Paul Tetlock.

Nearly all leading academics, not known for their attraction to unanimity, have publicly supported event markets. A great majority of these academics have been supplied with Intrade market data in the past, a service that Intrade intends to continue, for all study leads to an increase in transparency and understanding of event markets. It seems that the leading event market academics make no distinction between the benefits derived from academic owned markets like Iowa Electronic Markets and commercial market platforms like Intrade.

Yet many academics, with some notable exceptions, do temper their policy prescription to suggest a “safe harbor” for academic sites where research might be more generally available. As noted above Intrade has gladly supplied its event market data, typically free of charge to most of the leading prediction market academics and their students, and we are committed to encouraging the future study of event markets by continuing to supply our event market data free of charge or at very deep discounts. The academics that study event markets do a great service in developing our understanding of the strengths and weaknesses of event markets. Some commentators suggest that market liquidity and breadth typically benefit all event market stakeholders. Thus far commercial platforms like Intrade seem to be providing the greatest depth and breadth in event markets.

As Intrade has been a staunch supporter of event market academic study, and supplies greater depth and liquidity in its event markets than any other platform, it seems strange not to be a preferred purveyor. Perhaps the predominant reason many academics have held back from advocating and treating all event markets alike is a sense that initiatives to clarify or unwind the legislation restraining the optimal development of event markets is unlikely to be achievable. It seems many academics and commentators suggest a slow bureaucratic and pragmatic caution rather than focus on the optimal result. While the optimal result may be more challenging to achieve, for consistency, for better price discovery for the benefit of all, as well as for the development of Intrade, we encourage CFTC to apply common goals, objectives and standards for all participants.

While some evidence and event markets have highlighted that event markets do not always provide robust predictive information, the preponderance of the research suggests that event markets have both the ability and track record of providing the best available information upon which decisions may be based or optimised. Of course the uncertain regulatory status of event markets constrains the development of liquidity, price discovery and by logical extension societal benefits.

Intrade has received testimonials from numerous U.S. regulated businesses and private citizens which state they would like to trade on certain event markets but are unable due to the regulatory uncertainty. Therefore, unless and until event markets are given a certain status they will not develop to their full potential.

Based on the above and comments by many others, some of whom have been mentioned by name in this comment, the price discovery mandate that the CFTC has can only be served if event markets are embraced.

In terms of offsetting price risk and the opportunity for hedging, the overwhelming majority of markets listed by Intrade can easily be seen to have underlying economic implications and risks. For example, U.S. tax rate changes, a negative geopolitical event, an increase in the threat level to homeland security and the associated costs of a higher threat level, or indeed Social Security reform all have massive economic justifications across society.

As with the CFTC’s price discovery mandate, it is impossible for us to imagine how risks can be optimally assessed and managed without the status of event markets being clarified.

The CFTC are also sensitive to retaining the competitiveness of futures markets and retaining “competition in the global marketplace”. There has been much written about the United States losing its edge in global financial markets. Often cited is that burdensome and inflexible regulations, most notably the Sarbanes-Oxley legislation passed by Congress in 2002, are driving business to London, Hong Kong, Frankfurt and elsewhere. In this regard, the CFTC has an opportunity to be a world first and embrace event markets. In so doing the CFTC will ensure the United States’ leadership position is encouraged for the important and growing event market industry.

The greatest challenge in bringing about an appropriate and successful embrace of event markets by the CFTC is unlikely to be identifying and agreeing that the public good will be served, or that risks may be better managed. The challenge for the CFTC may well be the uncertainties relating to legal and jurisdiction issues. In these matters there are experts far better versed than Intrade to opine.

The financial events of the last six months in which virtually the entire world financial system stopped functioning to a greater or lesser extent has highlighted what can happen when many of the world’s largest financial institutions make concurrent similar mistakes. Such systemic contagion has led commentators to suggest a more fundamental approach to how and what we regulate. Where event markets are concerned we are hopeful that this is the case and that the level of regulation is such that the evolving stage of the event market industry is not stifled.

We are proud to be at the forefront of the development of the event market industry. We are determined to continue providing the best information on relevant event markets to the widest audience. We wish to solidify our regulatory position in the U.S. and elsewhere. We strongly encourage the CFTC to clarify the situation with regard to event markets for the benefit of all, even if there are costs to Intrade. We are highly optimistic that the CFTC will grasp this opportunity to benefit all society and we wish to serve our own most important role in an industry niche that we have been privileged to help shape.

Respectfully Submitted on behalf of the entire Intrade Team by
John Delaney
Chief Executive Officer

CC to Fax 202.418.5521 and e-mail: secretary@cftc.gov.

1. “Intrade … isn’t just an entertaining Web site. It is the latest iteration of one of the most important economic developments of modern times.” David Leonhardt, Economics Reporter, The New York Times, February 14, 2007

2. Costs of regulation are high in the U.S., “that’s a key reason the leading commercial prediction market, Intrade, is based in Ireland” Prof Paul Tetlock, Wall Street Journal, May 11th 2007

3. “On Dec. 11, 2003, Intrade’s contract on Saddam Hussein’s capture suddenly began to move. … Two days later, Saddam was in custody.” Bill Saporito, Time Magazine, October 24, 2005

4. “At FORTUNE we often write about the latest hot company, but it’s rare that we get a chance to introduce you to an entirely new market… Intrade is the only efficient market system around for investing in, well, almost anything” Andy Serwer, Managing Editor, Fortune, August 8, 2005

5. 78% of traffic to Intrade.com in the period 1 January to 30 June was from the U.S.

6. “Intrade futures market ~ the greatest time-saving invention of this century.” John Tierney The New York Times

7. The Uncertainty Stress Scale: its development and psychometric properties. Can J Nurs Res. 1994 Fall;26(3):15-30, PMID: 7889446

8. As of June 30 2008

9. For many people, Intrade is the king of the prediction markets.” Stephen Dubner, Freakonomics, The New York Times July 5 2007

10. http://www.whitehouse.gov/homeland/book/sect5.pdf.

11. http://feedroom.businessweek.com/?fr_story=5a3aa8086dbd52b35ae21c7f5abe94f85fa0a8ab&rf=sitemap.

12. http://www.energy.gov/news/5920.htm

13. “Want straight answers on what will happen in politics and current events? Answers without partisan bias or wishful thinking? You can’t do much better than the prices at Intrade.” Professor Robin Hanson, Professor of Economics, George Mason University

14. “My forecast? Prediction markets will become ever more important to business and public policy. And Intrade are running the most interesting markets around.” Professor Justin Wolfers

15. http://www.whitehouse.gov/news/releases/2001/06/20010611-2.html

16. “Analysts can debate about a recession as much as they want, but talk is cheap. It’s great to have [Intrade] futures trade where people put money behind their beliefs!” Professor Mark J. Perry, University of Michigan-Flint

17. http://www.international-economy.com/TIE_Sp07_Baker.pdf and http://knowledge.emory.edu/article.cfm?articleid=1015

18. “Regulatory Underkill,” Arthur Levitt Jr., Wall Street Journal, March 21, 2008

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NEXT: More from John Delaney about regulations

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CFTC’s Concept Release on the Appropriate Regulatory Treatment of Event Contracts

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SUMMARY:

The Commodity Futures Trading Commission (Commission or CFTC) is soliciting comment on the appropriate regulatory treatment of financial agreements offered by markets commonly referred to as event, prediction, or information markets. \1\ For ease of reference and to avoid classification issues, these financial agreements are referred to herein as event contracts. In general, event contracts are neither dependent on, nor do they necessarily relate to, market prices or broad-based measures of economic or commercial activity. \2\ Rather, event contracts may be based on eventualities and measures as varied as the world’s population in the year 2050, the results of political elections, or the outcome of particular entertainment events. \3\ The Commission’s staff has received a substantial number of requests for guidance on the propriety of trading various event contracts under the regulatory rubric of the Commodity Exchange Act (CEA or Act). Given the substantive and practical concerns that may arise from applying federal regulation to event contracts and markets, the Commission believes that it is appropriate to solicit and consider the public’s comments in advance of issuing any definitive guidance.

\1\ See Michael Gorham, Event Markets Campaign for Respect, Futures Industry Magazine (Jan./Feb. 2004); Justin Wolfers and Eric W. Zitzewitz, Prediction Markets, 18 J. Econ. Persp. 107 (Spring 2004); Robert W. Hahn and Paul C. Tetlock, Using Information Markets to Improve Public Decision Making, AEI-Brookings Joint Center for Regulatory Studies Working Paper 04-18 (March 2005); Hal R. Varian, Can Markets Be Used to Help People Make Nonmarket Decisions?, The New York Times (May 8, 2003).

\2\ The term event contract is not intended to encompass contracts that generate trading prices that predictably correlate with market prices or broad-based measures of economic or commercial activity, or contracts which substantially replicate other commodity derivatives contracts, such as binary options on exchange rates or the price of crude oil. The aforementioned contracts are unambiguously subject to CFTC regulation.

\3\ See, e.g., Retired claims list at the Foresight Exchange

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DATES: Comments must be received by July 7, 2008.

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ADDRESSES: Comments should be sent to the Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581, Attention: Office of the Secretariat. Comments may be sent by facsimile to 202.418.5521, or by e-mail to secretary@cftc.gov.

Reference should be made to the “Concept Release on the Appropriate Regulatory Treatment of Event Contracts.” Comments may also be submitted through the Federal eRuleMaking Portal at http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.regulations.gov.

FOR FURTHER INFORMATION CONTACT: Bruce Fekrat, Special Counsel, Office of the Director (telephone 202.418.5578, e-mail bfekrat@cftc.gov), Division of Market Oversight, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.

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SUPPLEMENTARY INFORMATION:

I. Introduction

A. Purpose of the Release

Since 2005, the Commission’s staff has received a substantial number of requests for guidance on the propriety of offering and trading financial agreements that may primarily function as information aggregation vehicles. These event contracts generally take the form of financial agreements linked to eventualities or measures that neither derive from, nor correlate with, market prices or broad economic or commercial measures. Event contracts have been based on a wide variety of interests including the results of presidential elections, the accomplishment of certain scientific advances, world population levels, the adoption of particular pieces of legislation, the outcome of corporate product sales, the declaration of war and the length of celebrity marriages. In response to the various requests for guidance, and to promote regulatory certainty, the Commission has commenced a comprehensive review of the Act’s applicability to event contracts and markets. To further its review, the Commission is issuing this release to solicit the expertise of interested persons, including CFTC-registered markets, exempt markets, over-the-counter derivatives dealers, capital market participants, legal practitioners, state and federal regulatory authorities, academicians and research institutions with respect to the practical and regulatory issues relevant to regulating event contracts and markets.

Broadly speaking, the Commission must determine:

1. Whether event contracts are within the Commission’s jurisdiction and if so, why (or why not)?

2. If event contracts are within the Commission’s jurisdiction, should there be exemptions or exclusions applied to them and if so, why (or why not)?

3. How should the Commission address the potential gaming aspects of some event contracts and the possible pre-emption of state gaming laws?

The Commission urges interested persons to provide detailed and comprehensive comments that will assist the Commission in conducting its review and analysis of the Commission’s regulatory purview over event contracts, the interests that may appropriately underlie Commission-regulated transactions, and the appropriate regulatory treatment of markets that may offer event contracts.

B. CFTC Experience With Event Contracts

The Iowa Electronic Markets (IEM), an electronic trading facility that functions as an experimental and academic program, is one of the better known and oft discussed real-money event markets currently in operation. \4\

The IEM operates in part pursuant to a 1993 no-action letter issued by Commission staff which, without asserting jurisdiction or describing the potential parameters of the Commission’s regulatory purview over the market, allows the IEM to list various event contracts subject to certain conditions and limitations for covered contracts. \5\

\4\ The IEM is run by the University of Iowa Departments of Accounting and Economics and the University’s College of Business Administration.

\5\ CFTC Staff Letter No. 93-66 [1992-1994 Transfer Binder] Comm. Fut. L. Rep. (CCH) ] 25,785 (June 18, 1993). This no-action letter superseded the operative terms of a more limited letter issued to the IEM in 1992. The 1993 letter’s relief extends to IEM contracts based on political elections, economic indicators, and certain currency exchange rates. The letter requires that the IEM limit access to any one submarket to between 1,000 and 2,000 traders. The letter also sets the maximum amount that any single participant can risk in any one submarket at five hundred dollars. The letter makes clear that relief is premised on, among other factors, the IEM’s representations concerning the market’s specific manner of operation and academic purpose, and the assurance that the IEM will not receive any profit or other form of compensation from its activities.

The IEM continues to be most recognized for its presidential election contracts. The IEM offers a vote share contract and a winner-take-all contract for the 2008 U.S. presidential election cycle.

Its vote share contract is ultimately associated with the candidates that will be nominated by each party. Each vote share contract has a maximum value of $1 and a contract payout that is directly based on the percentage of the popular vote received by each of the two major party candidates. For instance, a contract for a candidate who receives 40% of the popular votes cast for both candidates will be worth $.40 at settlement.

In contrast, the IEM’s 2008 presidential election winner-take-all contract will have a value of either $1 or $0 at settlement. The IEM’s winner-take-all-contract is also associated with a specific candidate, but instead of having a payout that is tied to a particular percentage of the popular vote received by each candidate, the contract will distribute a fixed payout of $1 to its holder if and only if the candidate referenced by the contract receives a greater percentage of the popular vote cast.

Although the IEM’s presidential election contracts are imperfect vehicles for the discovery of information, there is some consensus on the question of whether the IEM’s contracts can function capably as predictive tools. \6\ Indeed, trading data generated by some IEM presidential election contracts arguably have produced better predictive indicators than data obtained from professional polling organizations. \7\

\6\ See, e.g., Michael Abramowicz, Information Markets, Administrative Decision Making, and Predictive Cost-Benefit Analysis, 71 U. Chi. L. Rev. 933, 950 (2004).

\7\ See Cass R. Sunstein, Group Judgments: Statistical Means, Deliberation, and Information Markets, 80 N.Y.U. L. Rev. 962, 1029-31 (June 2005).

II. Commodity Options and Futures and the Attributes of Event Contracts

The Commission, with some exceptions, has exclusive jurisdiction over two relevant types of derivative instruments —commodity options and commodity futures contracts.

Section 4c(b) of the Act gives the Commission plenary jurisdiction over commodity options, and provides that “[n]o person shall * * * enter into * * * any transaction involving any commodity regulated under this Act which is of the character of, or is commonly known to the trade as, an option * * * contrary to any rule, regulation or order of the Commission[.]”

Section 2(a)(1)(A) of the Act provides that the Commission shall have exclusive jurisdiction with respect to accounts, agreements, and transactions (including options) involving contracts of sale of a commodity for future delivery.

Event contracts, depending on their underlying interests, can be designed to exhibit the attributes of either options or futures contracts.

A significant number of event contracts are structured as all-or-nothing binary transactions commonly described as binary options. \8\ Binary event contracts typically pay out a fixed amount when an outcome either occurs or does not occur. The trading of such contracts can facilitate the discovery of information by assigning probabilities, through market-derived prices, to discrete eventualities. For example, a binary contract based on whether a particular person will run for the presidency in 2012, can pay a fixed $100 to its buyer if and only if that individual runs for the presidency in 2012. If the contract’s traders believe that the likelihood of the individual’s candidacy in 2012 is around 17 percent, the price of the contract will be around $17, and will approximate the market’s consensus expectation of the individual’s candidacy.

\8\ See, e.g., Intrade Prediction Markets, Current Events Contracts

In addition to binary event transactions, the term event contract has also been used to identify transactions, based on interests other than market prices, which resemble futures contracts. For instance, these types of event contracts can price consensus estimates of moving values, such as the number of hours the average U.S. resident spends in traffic or the share of votes that a particular candidate for political office may receive. Unlike binary transactions, and similar to any commodity futures contract, this type of contract creates continuous and ongoing obligations that are linked to moving measures or levels, as opposed to being dependent on the outcome of a single discrete occurrence.

III. The Commission’s Regulatory Purview

As discussed above, with some limited exceptions, the regulatory purview of the Act extends to and includes transactions that are either structured as options or futures when such transactions involve interests that constitute commodities under the Act.

Section 1a(4) of the Act defines commodity in two distinct ways. First, Section 1a(4) specifically enumerates certain articles or goods as commodities. \9\

Second, Section 1a(4) defines the term commodity as including those articles or goods, and services, rights or interests, “in which contracts for future delivery are presently or in the future dealt in.” Therefore, an underlying interest that is not enumerated in Section 1a(4) may be a statutory commodity under the Act if it reasonably can underlie a futures contract on a forward looking basis. \10\

\9\ 7 U.S.C. 1a(4). Section 1a(4) of the Act enumerates the following commodities: wheat, cotton, rice, corn, oats, barley, rye, flaxseed, grain sorghums, mill feeds, butter, eggs, Solanum tuberosum (Irish potatoes), wool, wool tops, fats and oils (including lard, tallow, cottonseed oil, peanut oil, soybean oil, and all other fats and oils), cottonseed meal, cottonseed, peanuts, soybeans, soybean meal, livestock, livestock products, and frozen concentrated orange juice.

\10\ See United States v. Valencia, No. H-03-024, 2003 WL 23174749 at *8 (S.D. Tex Aug. 25, 2003) (noting that the determination of whether West Coast natural gas is “a commodity in which contracts for future delivery are presently or in the future dealt in,” is a fact question, and that “there is no evidence that West Coast gas could not in the future be traded on a futures exchange.”).

In addition to Section 1a(4), Section 1a(13) of the Act identifies certain interests as excluded commodities and thereby gives further shape to the statutory definition of commodity. \11\ The Section 1a(13) definition of excluded commodity is composed of four subsections. The third subsection defines the term to include any economic or commercial index that is based on prices, rates, values, or levels not within the control of any party to the relevant contract. The fourth subsection of Section 1a(13) provides that an excluded commodity includes an occurrence, extent of an occurrence, or contingency associated with a financial or economic consequence that is not within the control of the parties to the relevant transaction.

\11\ 7 U.S.C. 1a(13). Section 1a(13) of the Act provides that:

The term “excluded commodity” means–

(i) an interest rate, exchange rate, currency, security, security index, credit risk or measure, debt or equity instrument, index or measure of inflation, or other macroeconomic index or measure;

(ii) any other rate, differential, index, or measure of economic or commercial risk, return, or value that is–

(I) not based in substantial part on the value of a narrow group of commodities not described in clause (i); or

(II) based solely on one or more commodities that have no cash market;

(iii) any economic or commercial index based on prices, rates, values, or levels that are not within the control of any party to the relevant contract, agreement, or transaction; or

(iv) an occurrence, extent of an occurrence, or contingency (other than a change in the price, rate, value, or level of a commodity not described in clause (i)) that is–

(I) beyond the control of the parties to the relevant contract, agreement, or transaction; and

(II) associated with a financial, commercial, or economic consequence.

For the purpose of discussion and analysis, the types of event contracts that Commission staff has reviewed can be categorized, albeit imperfectly, as contracts that are based on narrow commercial measures and events, contracts based on certain environmental measures and events, and contracts based upon general measures and events.

Narrow commercial measures quantify and reflect the rate, value, or level of particularized commercial activity, such as a specific farmer’s crop yield.

Narrow commercial events, on the other hand, are events that might, in and of themselves, have commercial implications, such as changes in corporate officers or corporate asset purchases.

Environmental measures can be characterized as quantifications of weather phenomena, such as the volatility of precipitation or temperature levels, that do not predictably correlate to commodity market prices or other measures of broad economic or commercial activity.

By comparison, environmental events can include the formation of a specific type of storm, within an identifiable geographic region, the likelihood of which will not predictably correlate to commodity market prices or measures of broad economic or commercial activity.

General measures can be described as measures that are not commercial or environmental measures. As such, general measures do not quantify the rate, value, or level of any commercial or environmental activity and can, for example, include the number of hours that U.S. residents spend in traffic annually or the vote-share of a particular presidential candidate.

Similarly, general events, such as whether a Constitutional amendment will be adopted or whether two celebrities will decide to marry, can be described as events that do not reflect the occurrence of any commercial or environmental event. The category of general measures and events can be further divided into a multitude of subcategories, such as political or entertainment measures or events.

Since 1992, Commission-regulated exchanges have listed for trading a variety of commodity futures and options contracts with payout terms based on interests other than price-based interests. These contracts involve interests as diverse as regional insured property losses, the count of bankruptcies, temperature volatilities, corporate mergers, and corporate credit events. \12\

While not strictly price-based, the interests underlying these contracts have been viewed by Commission staff as having generally-accepted and predictable financial, commercial or economic consequences.

In other words, unlike the interests that event contracts cover, these underlying interests have been viewed as measures and occurrences that reasonably could be expected to correlate to market prices or other broad-based commercial or economic measures or activities.

\12\ For example, the Chicago Board of Trade’s catastrophe single event insurance option contracts (which are no longer listed) paid out a fixed amount if and only if insured property damage exceeded $10 billion for a specific region during a specified interval of time.

IV. Further Statutory Background

Federal regulations were initially applied to commodity derivatives trading in 1921. \13\ At that time, Congress acknowledged that commodity futures markets could benefit commerce by facilitating the hedging of commercial risks and the discovery of reliable commodity prices. \14\ The Grain Futures Act of 1922, the forerunner to the CEA, consequently was enacted to promote the financial vitality of futures trading by limiting price manipulations and other disturbances that were prevalent at the time and widely perceived to result from excessive speculation. \15\

\13\ See, e.g., Hearing on Futures Trading Before the House Committee on Agriculture, 66th Cong., 3rd Sess. 1043 (1921); Hearings on H.R. 5676 Before the Senate Committee on Agriculture and Forestry, 67th Cong., 1st Sess. 452 (1921); Hearings on Futures Trading Before the House Committee on Agriculture, 67th Cong. 1st Sess. 7-9 (1921); 61 Cong. Rec. 4761 (1921) (remarks of Senator Capper, the sponsor of the Senate bill which became the Futures Trading Act of 1921 (later restyled as the Grain Futures Act of 1922 when found to be unconstitutional for its use of taxation to penalize off-exchange futures trading)).

\14\ See S. Rep. No. 871 (August 23, 1922). The Congressional record is replete with discussion of the commercial importance of commodity futures trading. The record suggests that commercial interests must be able to look to properly functioning commodity futures markets for market information and products that facilitate the making of marketing, financing, and distribution decisions. S. Rep. No. 93-1131, at 12 (1974). The Congressional record also indicates that an initial purpose behind regulating commodity futures trading was to secure fair and orderly markets for producers and other commercial participants who used the markets for price basing and hedging. Hearings on S. 2485, S. 2578, S. 2837 and H.R. 1311 before the Senate Committee on Agriculture and Forestry, 93d Cong., 2d Sess. at 234 (1974); see also 80 Cong. Rec. 10739 (April 11, 1974).

\15\ E.g., 61 Cong. Rec. 4761-4763 (1921) (remarks of Senator Capper); 61 Cong. Rec. 1379 (1921) (remarks of Rep. Bland); 61 Cong. Rec. 1313-1314 (remarks of Rep. Tincher, the sponsor of the House bill which became the 1921 Act); 61 Cong. Rec. 1376 (1921) (remarks of Rep. Gensman).

In identifying the national public interests that render federal regulation necessary, the Act focuses on the commercial benefits that well-functioning derivatives markets can provide by broadly expressing their critical functions. Customarily, hedging and price basing have been identified as two critical functions of the commodity derivatives markets. \16\ For instance, Section 3 of the Act, as amended by the Commodity Futures Modernization Act of 2000 (CFMA), \17\ finds that transactions subject to the CEA are affected with the national public interest because they provide a means for “managing and assuming price risks.” Section 3 of the Act also identifies price discovery and price dissemination as separate public interests warranting Federal regulation. \18\

\16\ Hedging occurs when positions acquired are economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise. See, e.g., 17 CFR 1.3(z) (definition of bona fide hedging). Price basing, a function of price discovery and dissemination, can occur when commercial entities enter into transactions in a particular commodity based upon commodity futures prices for that or a related commodity, oftentimes at a differential.

\17\ Appendix E, section 108, Pub. L. 106-554, 114 Stat. 2763.

\18\ The hedging and price basing purposes of commodity futures trading are emphasized in other provisions of the Act as well. See, e.g., 7 U.S.C. 6a, 6b, and 6c. As a matter of background, the provision in the Grain Futures Act that was the forerunner of current CEA Section 3 provided that:

Transactions in grain involving the sale thereof for future delivery as commonly conducted on boards of trade and known as “futures” are affected with a national public interest; that such transactions are carried on in large volume by the public generally and by persons engaged in the business of buying and selling grain and the products and by-products thereof in interstate commerce; that the prices involved in such transactions are generally quoted and disseminated throughout the United States and in foreign countries as a basis for determining the prices to the producer and the consumer of grain and the products and by-products thereof and to facilitate the movements thereof in interstate commerce; that such transactions are utilized by shippers, dealers, millers, and others engaged in handling grain and the products and by-products thereof in interstate commerce as a means of hedging themselves against possible loss through fluctuations in price; that the transactions and prices of grain on such boards of trade are susceptible to speculation, manipulation, or control, which are detrimental to the producer or the consumer and the persons handling grain and products and by-products thereof in interstate commerce, and that such fluctuations in prices are an obstruction to and a burden upon interstate commerce in grain and the products and by-products thereof and render regulation imperative for the protection of such commerce and the national public interest therein.

Grain Futures Act, ch. 369, 42 Stat. 998 (Sept. 21, 1922). In 1936, Congress restyled the Grain Futures Act as the Commodity Exchange Act and amended this provision to substitute the word “commodity” for “grain.” Pub. L. 74-675, section 2, 49 Stat. 1491 (June 15, 1936).

Although repealed by the CFMA, former Section 5(g) \19\ of the Act may be relevant to analyzing the findings and purposes discussed in Section 3 of the Act. Former Section 5(g) provided that the Commission could not designate a board of trade as a contract market unless the board of trade demonstrated that transactions for future delivery in the commodity for which designation as a contract market was sought “will not be contrary to the public interest.” \20\ The public interest test of Section 5(g) included an “economic purpose” test, subject to a final test of the public interest. \21\ The economic purpose test applied under former Section 5(g) was used to prohibit the trading of certain contracts. Notably, the economic purpose test regarding contracts appropriate for trading on a futures exchange was not necessarily congruent with the scope of the Commission’s jurisdiction. Accordingly, while futures contracts that failed the economic purpose test were prohibited from trading on futures exchanges and thus illegal because of the on-exchange trading requirement, they (and any instrument with identical terms) remained futures contracts, fully subject to the Commission’s jurisdiction.

\19\ 7 U.S.C. 7(g), as amended by the Commodity Futures Trading Commission Act of 1974, Pub. L. 93-463, 88 Stat. 1389 (1974). In 1992, Section 5(g) was redesignated Section 5(7) of the Act. See Futures Trading Practices Act of 1992, Pub. L. 102-546, 106 Stat. 3590 (1992). The CFMA repealed all of former Section 5 of the Act, including Section 5(g) (redesignated as Section 5(7)), and replaced it with current Section 5. Section 5 was radically restructured by the CFMA to provide for designation criteria and core principles with which a DCM must comply. Appendix E of Pub. L. 106-554, 114 Stat. 2763 (2000).

\20\ 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).

\21\ See H.R. Rep. No. 1383, 93d Cong., 2d Sess. 36 (1974).

By enacting the CFMA, Congress sought “to promote innovation for futures and derivatives and to reduce systemic risk by enhancing legal certainty in the markets for certain futures and derivatives transactions[.]” \22\ As demonstrated by the IEM, innovative event markets have the capacity to facilitate the discovery of information, and thereby provide potential benefits to the public. Subject to certain exceptions, Section 4(c)(1) of the Act gives the Commission the authority to “promote responsible economic or financial innovation and fair competition” by exempting any transaction or class of transactions from any of the provisions of the Act, including the requirement that they trade on Commission-regulated markets, where the Commission determines that such action would be consistent with the public interest. Pursuant to Section 4(c), Congress gave to “the Commission a means of providing certainty and stability to existing and emerging markets so that financial innovation and market development can proceed in an effective and competitive manner.” \23\ Under Section 4(c), the Commission has the discretion to grant an exemption to certain classes of transactions without having to make a determination that such transactions are subject to the Act in the first instance. \24\ Notably, the Commission can use its Section 4(c) exemptive authority not only on a case-by-case, or product-by-product basis, but may also use the authority to establish a set of regulatory provisions applicable to a defined class of products.

\22\ House Report No. 106-711(III) September 6, 2000.

\23\ House Conference Report 102-978, 1992 U.S.C.C.A.N. 3179, 3213.

\24\ With respect to the exercise of this discretion, the House-Senate Conference Committee responsible for the review of Section 4(c) stated that:

The Conferees do not intend that the exercise of exemptive authority by the Commission would require any determination beforehand that the agreement, instrument, or transaction for which an exemption is sought is subject to the Act. Rather, this provision provides flexibility for the Commission to provide legal certainty to novel instruments where the determination as to jurisdiction is not straightforward. Rather than making a finding as to whether a product is or is not a futures contract, the Commission in appropriate cases may proceed directly to issuing an exemption.

Conf. Report at 3214-3215. Although Section 4(c) only speaks to futures contracts, Section 4c(b) of the Act, the Commission’s plenary authority to regulate transactions that involve commodity options, provides the Commission with comparable exemptive authority for options.

V. Issues for Comment

A. Request for Comment

The following questions consider the Commission’s regulatory purview over event contracts, the interests that may appropriately underlie Commission-regulated transactions, and the appropriate regulatory treatment of event contracts. The Commission encourages comments on the specific questions posed, as well as the broad range of issues raised in this concept release. In providing comments, please describe your relevant experience and discuss in detail the facts and legal provisions that support your conclusions. Furthermore, please consider the Commission’s mandate to protect commodity futures and options markets and customers, and ensure the integrity of the commodity derivatives marketplace, as well as the expected effects of any Commission action on competition, efficiency, innovation and the financial integrity of transactions. Any recommendation with respect to the regulatory treatment of event contracts and markets should be consistent with and supported by the Act, practical, and amenable to effective and efficient implementation.

B. Public Interest

1. What public interests are served by event contracts that are designed and will principally be traded for information aggregation purposes and not for commercial risk management or pricing purposes?

2. How are these interests consistent with the public interest goals embodied in the Act?

3. What calculations, analyses, variables, and factors could be used to objectively determine the social value of information to the general public that may be discovered through trading in event contracts? Should this be a factor in determining whether the Commission plays a role in regulating these markets?

C. Jurisdictional Determinations

4. What characteristics or traits are common to or should be used to identify event contracts and event markets?

5. How do these characteristics and traits differ from those of commodity futures and options contracts that customarily have been regulated by the Commission? How are they similar?

6. Are there criteria based on the provisions of the Act that could be used to make jurisdictional determinations with respect to event contracts and markets?

7. Given the purposes and history of the Act, would it be appropriate for the Commission to apply a test premised on commercial risk management or pricing functions to demarcate the Commission’s jurisdiction over particular contracts? If so, what factors could be used to make such a determination?

8. Given the purposes and history of the Act, would it be appropriate for the Commission to apply any test premised on the economic purpose of certain types of transactions to demarcate the Commission’s jurisdiction over particular contracts? If so, what factors could be used to make such a determination?

9. What calculations, analyses, variables and factors would be appropriate in determining whether the impact of an occurrence or contingency will result in a financial, commercial or economic consequence that is identified in Section 1a(13) of the Act?

10. What calculations, analyses, variables, and factors would be appropriate in determining whether an economic or commercial index that is based on prices, rates, values, or levels should or should not qualify as an excluded commodity under Section 1a(13) of the Act?

11. What identifiable factors, statutorily based or otherwise, limit the events and measures that may underlie event contracts when such contracts are treated as Commission-regulated transactions?

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?

13. The Commission notes that Section 12(e) of the Act generally provides that the CEA supersedes and preempts other laws, including state and local gaming and bucket shop laws, with respect to transactions executed on or subject to the rules of a Commission-regulated market, or with respect to transactions exempted from the Act pursuant to the Commission’s exemptive authority under Section 4(c) of the Act. What are the implications of possibly preempting state gaming laws with respect to event contracts and markets that are treated as Commission-regulated or exempted transactions?

14. Should certain underlying events or measures –such as those based on assassinations or terrorist activities– be prohibited altogether due to the social perception and impact of such events? What statutory or other legal basis would support this treatment?

15. Are there event contracts, such as political event contracts, that should be prohibited from trading under the Act, or that deserve separate treatment or consideration, due to the nature and importance of their outcomes? What statutory or other legal basis would support this treatment?

D. Legal Implementation

16. Is it appropriate for the Commission to direct certain or all event contracts onto markets that are regulated differently from and perhaps less stringently than DCMs? For example, it may be warranted or necessary to treat event markets that aggregate information solely for academic or research purposes, event markets set-up for internal corporate purposes, or event markets that offer exceedingly low notional value contracts to traders differently than markets that possess the attributes of traditional DCMs.

17. Is it appropriate for the Commission to use the Section 4(c) exemptive authority of the Act for implementing a regulatory scheme for event contracts and markets? In this regard, the Commission notes that it has the discretion to grant an exemption under Section 4(c) to certain classes of transactions without having to make a determination as to whether such transactions are subject to the Act in the first instance.

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?

19. What are the benefits and drawbacks of permitting certain event markets to operate pursuant to Commission established conditions that are similar to the conditions under which the IEM operates?

E. Market Participants

20. Would it be appropriate to allow market participants, and in particular, retail customers, to trade on Commission-regulated event markets with the knowledge that the Commission may not be able to effectively monitor the measures or events that underlie certain event contracts?

21. What unique protections and prophylactic measures are appropriate or necessary for the protection of retail users of event contracts and markets?

22. What are the implications of permitting the intermediation of event contracts, including intermediation on behalf of retail market participants, both with respect to trade execution and clearing?

23. Are there any types of trader or intermediary conduct, peculiar to event contracts and markets, that should be prohibited or monitored closely by regulators?

24. What other factors could impact the Commission’s ability, given its limited resources, to properly oversee or monitor trading in event contracts?

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Issued in Washington, DC, on May 1, 2008 by the Commission.

David A. Stawick,

Secretary of the Commission.

[FR Doc. E8-9981 Filed 5-6-08; 8:45 am]

BILLING CODE 6351-01-P
Last Updated: May 7, 2008

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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.

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BACKGROUND INFO:

- How the CFTC 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)

- What Vernon Smith told the CFTC.

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

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APPENDIX:

Paul Wolfowitz’s profile at the American Enterprise Institute

- How the neo-cons drove the United States of America into the unecessary Iraq war

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Bloggers like Mr. Reynolds [a university professor] tend to do well on the site, since they can promote their work and offer links to their articles.

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Social Science Research Network – (SSRN)

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Previously: BetFair’s Mark Davies on sports betting and the fight against corruption

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Our good friend Barry Ritholtz.has persuaded himself that our real-money prediction markets suffer from an irremediable and fatal problem: liquidity on political event derivative markets is too thin for smart Wall Street people like him to take their market-generated probabilities seriously. Barry Ritholtz is keen to tout oranges–apples comparisons: the NYSE volume versus the Obama–Clinton volume at InTrade. It’s a bullshit argument, but he managed to persuade some gullible journalists writing for some clueless mainstream media that thin liquidity was responsible for the New Hampshire upset —and else.

Barry, if you had 1,000,000,000 trades on the New Hampshire prediction market, you’d still have an inaccurate prediction. The polls were wrong, and there’s nothing … NOTHING… that the InTrade and BetFair traders could have done to get this election right. Get over it, Barry. Traders are not magicians.

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[For why the polls were wrong, see: The New York Times, Zogby, Rasmussen, Gallup...]

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John McQuaid of Wired.

1. It’s incoherent to start a rant against prediction markets by this upbeat line, “Prediction markets can be spookily accurate.”
2. He blames the New Hampshire upset on poor liquidity. Where is the scientific evidence of that? Total invention by our good friend Barry Ritholtz. The New Hampshire prediction markets were wrong because the advanced, primary indicators (the polls) were wrong. As simple as that. [For why the polls were wrong, see: The New York Times, Zogby, Rasmussen, Gallup...]
3. Prediction markets “have a lot of political junkies but few real insiders or outsiders, so they’re not very good at catching something the polls might miss.” Hummm… Most of the “real insiders” don’t keep scoops for themselves (if and when they have some), they are too happy to act as a source for some thirsty journalists or bloggers, so as to have their name printed somewhere. Hence, the political junkies would be able to aggregate any kind of extraordinary information —if that were to happen.
4. How could the prediction markets “get out ahead of conventional wisdom”? It’s impossible, other than by reversing our psychological arrow of time (remembering the future, instead of the past). At the contrary, the job of the prediction markets is to quantify exactly that so-called “conventional wisdom”. They won’t go further, and we’re happy to run with that, because, that way, we are not prisoner of the bias of a handful of experts. Plus, prediction markets give us an objective probability of event outcome —a thing that individual experts can’t give us.

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The excerpt below is good enough, though:

[...] But forecasting also needs more so-called noise traders, who do business with almost no information. Noise traders boost accuracy by increasing volume and the potential profits of informed traders. Diversity helps, too. If you can get different types of people to play, experts say, not only do you get a bigger pool and more information, but differing random guesses will cancel each other out, leaving real signals to rise above the noise. Plus, if you have a critical mass of investors with a variety of backgrounds, locations, and interests, they are less likely to move as a herd. [...]

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FOREMAN: I’ve got something I want you to take a look at. Look at this. It could be the price of a stock or a mutual fund. It isn’t. It’s the odds that a particular candidate, the red here is Hillary Clinton, who will become president of the United States. It’s called the predictive market. And while supporters say it’s no different than any other type of investment, for example, hog bellies or pork futures, or crude oil, it sure looks like gambling.

Economics Professor Koleman Strumpf is on the faculty at the University of Kansas School of Business to talk about it now. And in Las Vegas, another scholar in the art of predicting future events, Johnny Avello, the director of the Sports Book at Wynn, Las Vegas.

Let me start with you, professor. How well does this work? When people start betting online as to who’s going to win, does it work?

KOLEMAN STRUMPF, UNIVERSITY OF KANSAS: Yes, the markets have a really tremendous track record dating back at least on the online markets to 1988. And actually earlier, there were impromptu markets that existed outside of Wall Street in the early 20th century.

These things have been around for at least 100 years or probably more. 150 years. And with maybe only one or two exceptions that I can think of, they’ve done a just totally dead on job at forecasting.

[FOREMAN]: Long before polling existed, then you’re saying we had betting. And there were betting lines in newspapers. And if you want to know who’s winning the presidential race, that’s what you looked at?

STRUMPF: That’s exactly right. So in 1904, “The New York Times” reported on the front page what was going on at the Wall Street betting markets since there was no Gallup Poll that existed at that time.

FOREMAN: Johnny, why do you think that this is generally so successful compared to polling?

JOHN AVELLO, DIR. OF RACE & SPORTS, WYNN HOTEL: Well, first of all, you are taking actual bets. And you know, each person that puts their money up is a good indication of, you know, which way they like it.

When you’re doing polling, you know, that’s kind of an ambiguous way of finding out who the winner is because you’re getting a fraction of the people who you’re actually finding out who they like. So I like to call it money versus unpredictability.

FOREMAN: You’re saying the difference is that in a poll, somebody may say something that they believe in generally, or they think that the pollster wants to hear. But when they put money down, they’re going to really bet on what they think is going to happen?

AVELLO: It’s the real thing.

FOREMAN: It’s sort of interesting when you look at these different types of polls. There’s the In Trade system, which is out of Dublin, Ireland that’s sort of interesting. In Trade allows people to bet actual money and large amounts of it on all sorts of outcomes all around the world.

The Iowa markets is one the people have talked about a lot. Set up by a university there. Basically the Iowa markets allow people to bet in limited amounts of money. About $500. And it’s used simply to see how well this works for educational purposes mainly.

Professor, when we talk about these, though, why did polling ever become popular if betting works so well in telling how we would win?

STRUMPF: Well, I think a kind of — much like today, the newspapers, the media was always uncomfortable reporting these markets. There sort of was dubious legal status and maybe some moral issues with it.

Polling for whatever reason seems to have been morally acceptable to the media. And I think as a result when Gallup came around in the late 1930s, the betting markets kind of fell by the wayside. They never of course disappeared, but I think it was sort of a moral issue, the same kind of moral issues that I think arise today in thinking about gambling.

FOREMAN: So let me ask you this, Johnny. Why do you think it’s been so difficult this year, though? Because as far as we can tell, the betting lines have not done any better than the pollsters this year in predicting this election. It has been all over the map. And the betting has been all over the map.

AVELLO: Well, one thing to remember, Tom, is that when the book maker’s putting up a line, what they’re trying to accomplish is divided action. So they’re not trying to pick the winner because let’s take for instance if the book maker put up Hillary Clinton at one to two, and she was bet from to three to win the Democratic nomination. You know, and Obama won. People would say, wow, the book maker really got killed on that.

FOREMAN: The book maker’s not trying to predict it, but obviously, the gamblers are, the people who are betting on these things. And they haven’t done well this time, not compared to past elections. Why do you think that is? Why is this so hard to sort out?

AVELLO: Because they’re not always right. No one’s right at 100 percent of the time. I would say best case. You know, I know that history has shown that the bettor has done well on this. But to be perfectly honest with you, I think if you do 60 percent, you’ve done a great job of picking the winner.

FOREMAN: And Koleman, do you think there’s anything unique that’s making it harder for the betting markets to be as accurate as they had been in the past?

STRUMPF: Well, it’s obviously a close market and opinions are changing rapidly. I just want to kind of maybe extend a little on what Johnny just said in terms of thinking about what these markets mean.

The markets give us a probability of an event occurring. So even if, for example, Obama is a 80 percent favorite in the upcoming Wisconsin primary, which he is, that still means on the flip side that there’s a 20 percent chance that he’s not going to win. So the markets, again as Johnny had said, don’t – they – by sort of definition can’t predict an upset. An upset is a surprise which people hadn’t anticipated. So sometimes there are these quick shifts of opinion, which I — to the best of my knowledge, there’s no way to forecast that in advance.

FOREMAN: And this campaign has been just filled with them. Johnny, one last thing here. Any sense of where the smart money is going these days?

AVELLO: Well, let’s say that there’s been a shift. I believe the smart money was on Hillary Clinton early, and has shifted to Obama. But surprises do happen. And all you need to do is look at the Superbowl to find that out.

FOREMAN: Johnny, thanks so much. Koleman, as well. We appreciate you being here. And speaking of gambling, Madame Tussaud’s Wax Museum here in Washington is hedging its bet. And that kicks off our political side show.

Via prediction market pioneer Emile Servan-Schreiber of NewsFutures [*], the New York Times (2 pages):

At InterContinental Hotels, Zubin Dowlaty, vice president for emerging technologies, decided to create an online market last fall to “harvest and prioritize ideas” from within the hotel’s 1,000-person technology staff. “We wanted to tap the creative class that may not be able to voice their ideas,” Mr. Dowlaty said. With InterContinental’s prediction market, players were asked to submit ideas anonymously, with a description and the benefit to customers and company. The bettors were given virtual tokens, each receiving 10 green ones to be placed on the best ideas and three red for bad ideas. There were no limits on the number of times bettors could change their wagers as new ideas came to market, and the market was open for four weeks. The five top ideas (most green tokens), five bottom ideas (most red) and the top five bettors (most accurate, according to market consensus) were listed regularly. The winners got $500, while second- and third-place finishers received $250 each. The winners, Mr. Dowlaty said, were engineers, analysts and contractors, not managers. More than 200 people participated, submitting 85 ideas. One person proposed bringing back quarter-operated vibrating beds. “That one got beat down really fast,” Mr. Dowlaty said. The winning ideas were suggestions to improve searching the company’s Web site to find and book hotel rooms. Two projects have been started as a result of the market, Mr. Dowlaty said. Next, he said, prediction markets may be opened up to InterContinental’s customers, probably beginning with members of its Priority Club loyalty program. They could bet in markets for improving service and offerings, with points redeemed. “It’s the next frontier and the natural progression for this,” Mr. Dowlaty said.

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[*]

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InTrade-TradeSports, unlike BetFair-TradeFair, do manage internal, enterprise prediction markets.

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Previously: Do Google’s enterprise prediction markets work?

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Image Credit: Chris Gash for the New York Times

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Adam Siegel of Inkling Markets is also out with a post on that NYT article, but it is of no intellectual interest. Maybe Adam should blog less quickly and eat more fish.

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I forgot to tell you, the other day, that Best Buy is a Consensus Point client, but you knew that already.

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Previously: The New York Times is telling the business world that enterprise prediction markets are an essential management tool.

[Via Xpree]

Previously: Do Google’s enterprise prediction markets work?

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