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UPDATE: Some smart comments, just below…-
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BetFair:
Improvements to Betfair’s bet matching logic today, Monday 14th July:
What’s changing?
We’ve improved the code that matches bets. As well as matching backs against lays as we’ve always done, we’ll also try to match your bet against bets on other selections in the market. We‘ll give you an improvement over the price you‘ve requested where possible, and we‘ll match you against whichever bets get you the best price.
For example in a tennis market:
Roger Federer is 1.9 to back, 2.1 to lay.
Rafael Nadal is 1.8 to back, 2.0 to lay.
If you try to back Federer at 1.9 or less, previously we would have matched your bet against the customer looking to lay Federer at 1.9. Both bets would have been matched at 1.9, even if you‘d asked for a shorter price. In theory we could do even better than that though: we could match you against the customer trying to back Nadal at 2.0 (backing one player at 2.0 is of course the same as laying the other player at 2.0). Our new bet matching process will see which match gets you the better price. In this case we would get you 2.0 by matching you against the Nadal backer (who is offering a better price than the layer of Federer).
When placing a new bet you will only ever be matched by the new process if doing so gives you a better price than you would otherwise have got. We will match your bet at the best price possible that’s a valid increment on Betfair’s odds ladder, as we explained in our update of 6th June.
Does this only work for 2-runner markets like tennis?
No. The new matching logic works for any number of runners in a market. An example with a 2-runner market is probably easiest to understand, but the principle is the same for markets with 3 runners or more. For example if a football market looked like this:
Spain 2.3 to back, 2.5 to lay
Germany 3.9 to back, 4.0 to lay
The Draw 2.9 to back, 3.0 to lay
Then if you want to back Spain we could match you with customers looking to back Germany and the Draw at 4.0 and 3.0 respectively, which would result in you being matched at 2.4, a better price than you would have got had we matched you against Spain layers (who are only offering 2.3).
Which markets will this affect?
We’ll introduce the new code on Monday 14th July, but initially matching will be done exactly as before. As explained earlier in the year, introducing best execution across selections wasn’t possible without significant change to the existing code that matches backs and lays, so we will need verify that performance is as expected for the existing matching process before enabling the new functionality. All being well we’ll enable the new code for a small number of markets to ensure that everything is as it should be later on Monday. We’ll announce which markets on Monday. Again if all is well we’ll roll out to a wider range of markets on Tuesday.
We’d expect to match across selections on the same range of markets as we currently do:
Match Odds in Basketball, Boxing, Cricket, Ice Hockey, Rugby League, Rugby Union, Snooker, Tennis and Volleyball, Greyhounds win markets, Darts match odds, correct score and handicaps and Soccer match odds, HT/FT, correct score and unders/overs.
Horse racing will not be covered for now, due to the possibility of non-runners, and the new process isn’t applicable to markets where runners can be added (for example “Next manager” markets), where runners listed might not take part (e.g. First Goalscorer) or where the runners in a particular “market” are treated independently (e.g. Accumulators).
What about bets placed in error?
We’re aware of a concern that this change might make it more likely that customers would match bets placed in error, for example asking for 1.2 when you really wanted to back at 2.2. One consequence of the change we’re making is that any bet you place is more likely to get matched – making it easier to get a match is the whole idea. Being realistic though, if you had placed a bet in error like that in the past, in the vast majority of cases you would have been matched (against lays on that selection). There’ll now be far, far more circumstances where you would have been matched anyway , but instead you’ll now get a better price, than situations where your bet would have been unmatched and you might have had the chance to cancel. On average we would expect customers who place bets in error to be better off as a result.
On a related point, we’d also expect this change to make it more difficult for people who place “trap bets” to get matched (a trap bet is an offer that is only likely to be matched if another customer places a bet in error). While putting up “trap bets” is against Betfair’s terms and conditions and we close the accounts of persistent offenders, on an exchange where any customer can ask for any price it’s difficult to eradicate this practice. In most instances where a trap bet is the best price available on a selection, customers will in future be matched at better prices against bets on other selections rather than matching the trap bet.
How will the change affect liquidity?
We would expect the change to be beneficial to liquidity. Obviously if we have opposing customer bets in the system that could be matched, whether on the same selection or across different selections, the best thing for liquidity is to match them.
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Further to the above, we’ll be enabling the improved matching on the following markets later today.
Football:
Czech Republic U19 vs. England U19
FC Inter vs. MyPa
Tennis:
Andujar vs. Hanescu
Minar vs. Rochus
Greyhounds:
11:28 Sheffield
11:48 Oxford
ELECTORAL COLLEGE MARKETS: Probabilistic predictions for the 2008 US presidential elections based on market data from InTrade Ireland —-(electoralmarkets.com).
By Lance Fortnow, David Pennock, and Yiling Chen. 
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For more on probabilistic predictions, go to our “-Predictions”- page, or visit the prediction exchanges.
Alternatively, if you want an electoral map made of polls, go to electoral-vote.com.
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Chris F. Masse
Midas Oracle
cfm —-—- midasoracle —-—- com
chrisfmasse —-—- gmail —-—- com
July 6th, 2008
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21st St. NW
Washington D.C. 20581
Attention:
Office of the Secretariat- [email protected]
Reference:
Concept Release on the Appropriate Regulatory Treatment of Event Contracts
73 FR 25669
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Just a technical note, before I give you my thoughts. In the following, I call “-prediction market”- the specific market where one particular event derivative is traded. (For instance, the “-Barack Obama will be elected US President in November 2008″- prediction market.) And I call “-prediction exchange”- the general marketplace where many prediction markets (on political elections and other events) are traded. (Hence, I call HedgeStreet a “-prediction exchange”-).
Please, allow me to give you my thoughts on the subject of real-money prediction exchanges:
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ABOUT THE INFORMATION AGGREGATION MECHANISM, FORECASTING, THE LIQUIDITY OF THE SOCIALLY VALUABLE PREDICTION MARKETS, THE DEVELOPMENT OF A US-BASED PREDICTION MARKET INDUSTRY, AND THE PROTECTION OF RETAIL TRADERS
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The information aggregation mechanism functions well only if there are enough traders. Probabilistic predictions (which are of interest of the economists cited in the CFTC’-s concept release) are generated only when there is enough liquidity, that is, when many traders come speculating on an event derivative market (e.g., on the topic of the next political election). Just because forecasters are interested in a topic and want to generate a market-based probabilistic prediction does not mean that traders will flock en masse. Market-generating forecasting is an offspring of the trading activity- if you have too little liquidity, you don’-t have any trustworthy probabilistic prediction.
The socially valuable prediction markets should meet 3 criteria:
– their contracts should be very well drafted, so that the probabilistic predictions generated would be useful to society-
– a sufficient number of traders should like the topic-
– there should exist advanced, primary indicators which traders can follow to get early information (e.g., polls, among other sources of information, in the case of prediction markets on political elections).
Here’-s a counter example. Yahoo! Research scientist David Pennock (one of the most active and well regarded researchers in this field) has created a set of prediction markets regarding the percentage share of web searches made in the US in 2008, for each Internet search engine (Google, Yahoo!, etc.) That would be extremely valuable, on the paper. Unfortunately, those sets of prediction markets have attracted only a fistful of traders:
http://www.intrade.com/aav2/trading/tradingHTML.jsp?evID=78364&-eventSelect=78364&-updateList=true&-showExpired=false
Hence, no trustworthy probabilistic predictions were generated.
The CFTC should take with a grain of salt the 2008 petition organized by the American Enterprise Institute
http://www.reg-markets.org/publications/abstract.php?pid=1276
that states that “-not-for-profit research institutions”- and “-government agencies”- should be allowed to run US-based, real-money prediction exchanges, for the good of society. Just because an organization is smart and fascinated by the prediction markets does not mean that its executives and managers will be capable of drawing traders. Obviously, prediction exchanges should be run by trading specialists and event derivative professionals, and properly regulated. No good will be done by the CFTC if amateurs are allowed to run un-regulated, real-money prediction exchanges.
I see 2 important keys for the development of socially valuable prediction markets.
a) The socially valuable prediction markets (which are not very popular, other than the ones on political elections) should be organized by the generalist prediction exchanges that draw traders en masse because they offer prediction markets on very popular topics.
Sports is a popular topic. If the CFTC go to the website of TradeSports http://www.tradesports.com/ , they will see that TradeSports links, on its frontpage, to the InTrade prediction markets at http://www.intrade.com/ and, thus, send the TradeSports traders to the InTrade prediction markets, which is obviously good for InTrade’-s liquidity in general, and especially good for InTrade’-s socially valuable prediction markets. In the same manner, the prediction markets on political elections organized by BetFair UK http://www.betfair.com/ are located within their central prediction exchange that is mainly devoted to sports.
The hard fact is that the most popular topic among individual traders (the retail customers of the prediction exchanges) is sports. As long as US laws and regulations won’-t allow US-based, real-money prediction exchanges to organize prediction markets on the topic of sports, many US event derivative traders will give their business to offshore, real-money prediction exchanges who accept to take money from US residents (as it is the case with TradeSports-InTrade Ireland).
I understand, though, that the CFTC is working under a jurisdiction that presently outlaws prediction markets on sports.
b) The executives of the popular, real-money prediction exchanges should be willing to create socially valuable prediction markets by collaborating with outside researchers who specialize in certain verticals.
As of today, InTrade is the only real-money prediction exchanges that fill these 2 criteria —-a) and b). InTrade’-s executives and managers have deployed a considerable effort to create and run an impressive number of socially valuable prediction markets.
BetFair UK have chosen not to develop socially valuable prediction markets, alas —-other than those on UK politics, which are well developed and of high social utility. And HedgeStreet does not have yet the CFTC’-s stamp of approval to run markets of event derivatives non-financial topics, since that’-s the purpose of the May 2008’-s concept release.
The economists Justin Wolfers, Eric Zitzewitz, Robin Hanson, Koleman Strumpf and David Pennock (among others) have collaborated with InTrade Ireland to frame interesting questions. Obviously, the research institutions which those economic scientists are affiliated with (e.g., universities, colleges, business schools) have no business running real-money prediction markets.
If the “-not-for-profit research institutions”- and “-government agencies”- want to develop socially prediction markets, then they should do it in cooperation with established, popular, regulated, real-money prediction exchanges, who know what they are doing.
(In passing, I fully support Tom W. Bell’-s point made in the 5th paragraph of his petition. The CFTC should not favor the not-for-profit prediction exchanges at the expense of the for-profit prediction exchanges. Tom W. Bell’-s comment to the CFTC has not yet appeared on the CFTC website, as I type this. http://agoraphilia.blogspot.com/2008/07/lets-tell-cftc-where-to-go.html )
As I said, I follow the prediction market industry since 2003, and the 2 most common mistakes I see made by
the people proposing brand-new socially valuable prediction markets are that:
– they forget that the event derivative traders should have fun-
– they forget that, for each prediction market, there should exist advanced, primary indicators that traders should rely on to inform their trades.
I want to tell the CFTC that most people who talk about creating brand-new socially valuable prediction markets are totally unaware of these 2 basic rules.
In the beginning of this comment, I said that prediction markets are forecasting tools (and, hence, decision-support tools) if, and only if, there is sufficient liquidity. I also noticed that the world’-s most liquid socially valuable prediction markets are offered by 2 exchanges (TradeSports-InTrade and BetFair) who use popular prediction markets (on sports, the fact is) to support the marketing of less popular, socially valuable prediction markets. (After making that argument, I acknowledged that the CFTC currently works for a legal environment that prohibits prediction markets on sports.)
My point here is to emphasize the uber importance of liquidity on socially valuable prediction markets. In my view, the best situation is when a big, generalist, real-money prediction exchange organizes socially valuable prediction markets and helps them to thrive. Only InTrade Ireland has done that, so far. My suggestion to the CFTC would be to create a legal environment such that their liquidity could be “-repatriated”- to the US, on a “-InTrade USA”- real-money prediction exchange.
A related issue is that the CFTC should be concerned about HedgeStreet’-s financial health. After its third round of funding, HedgeStreet raised a total of $24.9 million.
http://www.hedgestreet.com/abouthedgestreet/pressreleases/pressrelease_21.html
Lately, HedgeStreet was aquired by an offshore investor for $6 million.
http://www.hedgestreet.com/abouthedgestreet/pressreleases/pressrelease_32.html
Obviously, there has been destruction of wealth, here.
The CFTC did a great job in 2004 when it approved HedgeStreet’-s application as a Designated Contract Maker (DCM). The CFTC should now finish the job by creating a legal environment favoring the profitability of HedgeStreet and of other non-intermediated DCMs (e.g., InTrade USA, or BetFair USA, or TradeFair USA) —-which I hope will be started up in the future in the US.
What I am afraid with the May 2008’-s concept release on “-event markets”- is that the CFTC does not look into the real issues: the liquidity of socially valuable prediction markets, and the profitability of US-based companies operating real-money prediction exchanges (non-intermediated DCMs).
I’-m afraid that all the solutions consisting in “-exemptions”- and “-no-action”- letters are false solutions that do not address the real issues.
Finally, for the issue regarding the protection of retail traders, I suggest that the CFTC looks into the worst scandal that occurred in the field of prediction markets —-the “-North Korea Missile prediction market”- scandal. I am sad to say that InTrade Ireland acted in the worst way possible, and, thus, have indelibly tarnished their reputation, alas.
http://www.midasoracle.org/predictions/nkm-scandal/
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Thanks for listening,
Chris F. Masse
Panorama B, Green Side
305, avenue Saint Philippe
Les Templiers, Sophia–Antipolis
06410 Biot, Alpes-Maritimes
France, European Union
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RELATED POSTS:
– Chris Masse’-s first comment to the CFTC on “-event markets”- (prediction markets)
– What the CFTC is asking.
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Chris F. Masse
Midas Oracle
cfm —-–- midasoracle —-–- com
chrisfmasse —-–- gmail —-–- com
July 6th, 2008
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21st St. NW
Washington D.C. 20581
Attention:
Office of the Secretariat- [email protected]
Reference:
Concept Release on the Appropriate Regulatory Treatment of Event Contracts
73 FR 25669
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My name is Chris F. Masse, and I’-m the publisher of CFM (a vertical portal to prediction markets, which is the only one I know of that lists extensively the URLs of all the world’-s play-money and real-money prediction exchanges)
http://www.chrisfmasse.com/
and Midas Oracle (a group blog on prediction markets, which is the most popular resource on this topic).
http://www.midasoracle.org/
I’-ve been covering the prediction market industry since 2003 (when the brouhaha caused by the Policy Analysis Market attracted the attention of many). I would like to give my input to the CFTC on the subject of real-money prediction exchanges.
First of all, let me say that I welcomed:
#1. The CFTC’-s decision to investigate and approve HedgeStreet’-s application as a DCM in 2003 and 2004 (in spite of the opposition of the Chicago Mercantile Exchange)-
http://www.hedgestreet.com/abouthedgestreet/pressreleases/pressrelease_1.html
http://www.hedgestreet.com/faq/
http://www.financial-spread-betting.com/hedgestreet-application.pdf
http://www.cftc.gov/files/submissions/comments/comdcm038cme.pdf
#2. The CFTC’-s decision to publish a concept release on “-event markets”- in May 2008 (73 FR 25669).
http://www.cftc.gov/lawandregulation/federalregister/proposedrules/2008/e8-9981.html
Just a technical note, before I give you my thoughts. In the following, I call “-prediction market”- the specific market where one particular event derivative is traded. (For instance, the “-Barack Obama will be elected US President in November 2008″- prediction market.) And I call “-prediction exchange”- the general marketplace where many prediction markets (on political elections and other events) are traded. (Hence, I call HedgeStreet a “-prediction exchange”-).
Please, allow me to give you my thoughts on the subject of real-money prediction exchanges:
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ABOUT DISPERSED INFORMATION PRICED IN EVENT DERIVATIVE MARKETS, EXCLUDED COMMODITIES, DCMs, AND EXTENDING THE COMMENTING PERIOD ON THE CFTC’-s CONCEPT RELEASE ON “-EVENT MARKETS”-.
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#1. I fully agree with the point #2 made by professor Vernon Smith in his comment (CL01) to the CFTC.
http://www.cftc.gov/stellent/groups/public/@lrfederalregister/documents/frcomment/08-004c001.pdf
The information aggregation mechanism that constitutes the essence of each prediction market (for instance, the “-Barack Obama will be elected US President in November 2008″- prediction market), and the objective probabilistic predictions generated by all these information aggregation mechanisms, are of high social utility.
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#2. I fully agree with HedgeStreet in their comment to the CFTC (CL12) that political elections qualify as “-excluded commodities”-.
http://www.cftc.gov/stellent/groups/public/@lrfederalregister/documents/frcomment/08-004c012.pdf
The point made by HedgeStreet about economic consequences, risk management and hedging is extremely important with regards to:
– the future revenues of the for-profit, commercial companies who would be operating the real-money prediction exchanges on political elections (since hedging-oriented derivative markets experience much more volumes than speculative-only betting markets)-
– the financial innovations, which would be created by this process, and whose benefits will, on the long term, spread throughout society (just like what has happened with the traditional derivatives).
However, I notice that HedgeStreet does not state specifically whether the topics other than political elections (mentioned in the CFTC’-s concept release on “-event markets”-) qualify, too, as “-excluded commodities”-.
This issue is the cornerstone of the discussion on “-event markets”-. In the concept release, the CFTC mention many other prediction markets than those about political elections. I saw only one comment (from Jason Ruspini, CL11) that elaborates in detail about non-political “-event markets”- —-as of Sunday, Juy 6th, 2008, one day before the deadline for the commenting period.
http://www.cftc.gov/stellent/groups/public/@lrfederalregister/documents/frcomment/08-004c011.pdf
Hence, I believe that the CFTC do not (as of this Sunday) have enough pieces of external opinions about this important issue to make their determination about the regulatory status of “-event markets”-.
I am asking the CFTC to extend the deadline to September 7th, 2008.
I believe that since the most interesting comments (other than Vernon Smith’-s one, which appeared the first in May 2008) were made the last week preceding the July 7th deadline, there wasn’-t enough time for the previous commenters or some other commenters to agree or disagree with those recent comments.
On top of all that, I understand that some people and organizations might well submit their comment on Sunday, July 6th, 2008 —-the day before the deadline for the closure for the comments. I know that law professor Tom W. Bell will do so. It is rumored that 2 prediction exchanges will do so, too. It will be impossible for other commenters to assess those last comments, and give their opinion about those to the CFTC.
I believe that more people and organizations would come forward in the coming 2 months with interesting opinions about the “-excluded commodities versus exempt commodities”- debate (or some say, the “-jurisdiction vs. exemption”- debate), which is, as I understand it, the cornerstone of the CFTC’-s concept release on “-event markets”-. Indeed, some business media organizations I know of will publish news articles about this debate, after the July 7th deadline. Hence, many more people will be drawn in the conversation about “-event markets”-, and we will all benefit from their input.
As I said, one one hand, the debate needs more external comments from people arguing that non-political events are “-excluded commodities”-.
On the other hand, the debate needs more external comments from people arguing that about the “-exempt commodities”-, “-ECMs”-, or “-no-action letter”- points of view. The American Enterprise Institute’-s public petition of May 2008, the concept release of May 2008, and the comments sent to the CFTC published on the CFTC website as this Sunday, do not give many legal details about this side of the argument.
Pushing the deadline to September 7th, 2008 will allow another round of informal and formal discussions between the two sides of this important issue.
Already, one commenter (Jason Ruspini) is on the record publicly saying that, had he read the HedgeStreet’-s comment to the CFTC, he would have put more emphasis on some of his arguments.
http://www.midasoracle.org/2008/07/05/my-response-to-the-cftc-on-event-contracts/
It’-s for all those reasons that I am asking the CFTC to extend the deadline to September 7th, 2008.
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#3. I fully agree with HedgeStreet in their comment to the CFTC (CL12) that the DCMs (and especially a non-intermediated DCM like HedgeStreet
) should be allowed to operate prediction markets on political elections, as discussed by the CFTC’-s concept release of May 2008.
As I said above, not enough commenters have addressed the specific issue of how the non-political “-event markets”- should be regulated (or semi regulated, thru the “-exemption”- way). Hence, I can’-t see how the CFTC can’-t reach a wise decision on the issue of which type of “-event markets”- should be offered by which type of derivative exchanges (DCMs, ECMs, or exchanges that are granted a “-no-action”- letter).
Again, I am asking the CFTC to extend the deadline to September 7th, 2008.
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Thanks for listening,
Chris F. Masse
Panorama B, Green Side
305, avenue Saint Philippe
Les Templiers, Sophia–Antipolis
06410 Biot, Alpes-Maritimes
France, European Union
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RELATED POSTS:
– Chris Masse’-s second comment to the CFTC on “-event markets”- (prediction markets)
– What the CFTC is asking.
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Robin Hanson:
Date: Mon, 07 Jul 2008 10:12:46 -0400
To: [email protected]
From: Robin Hanson &[email protected]>-
Subject: Comment on “-Concept Release on the Appropriate Regulatory Treatment of Event Contracts”-
—-—-—-—-—-—-—-—-—-—-—-—-—-—-—-—-—-—-—-—-—–
I am an event market innovator, having published the first detailed discussions envisioning their widespread application, having designed a widely used trading mechanism (the market scoring rule), and having co-developed the first internal corporate markets (at Xanadu), the first public web markets (the Foresight Exchange), and the aborted-but-influential Policy Analysis Market.
As I am less well trained in law than social science, I will not comment on what the C.F.T.C. is legally authorized to do, but only on how various policies correspond to public interest and public opinion. I speak here only for myself and not for any organization with which I may be affiliated.
The degree and type of regulation appropriate for a financial market depends on traders’- motives. Long ago most everything beyond direct physical exchange was widely discouraged or prohibited as “-gambling”- or “-speculation.”- The motives imputed to traders seemed to be some combination of mistakes, overconfidence, thrill of action, love of risk, and showing off one’-s confidence and risk tolerance.
While public opinion on gambling has changed little, eventually legal exceptions were carved out for markets where, though speculation was still possible, enough participants had more sympathetic motives to garner public support. Securities markets allowed business managers to hedge ownership, insurance markets allowed hedging of various idiosyncratic risks, and commodities futures markets allowed hedging of various common risks.
It has long been noted approvingly that such speculative markets often had the desirable side effect of inducing people to collect info and aggregate it into prices. But until recently such info was not considered or accepted as a primary explanation or justification for a market’-s existence. Given the myriad ways our society now suffers, often dramatically, from failures to aggregate info, I am very optimistic about the long term potential for such markets to offer substantial social value. However, the question remains of how such info-motivated markets should be regulated today.
Ideally an entire new regulatory regime would be carved out, on par with regimes for securities, insurance, and commodities futures regulation. But who would bother with such an effort before such markets had proven themselves able to realize substantial social value? And how could such markets prove themselves without at least tentative legal spaces in which to experiment? I know of no good reason why the C.F.T.C. should not provide one of the first such spaces.
Two key issues face a new regulatory regime for info-motivated event markets, especially one carved out of a common-risk-hedging commodities-future regulatory regime:
How Does Optimal Regulation Differ Here?
On the first question, the largest difference I see, by far, is the appropriate scale. When hedging risks it makes sense to focus first on risks, and hence trades, which are a large fraction of the wealth of the individuals or organizations involved. If risks are common there should be many who trade if any trade, and so market volume should be many times individual wealth levels. It also makes sense to devote a small fraction of this volume to efforts to avoid foul play. I have heard that it costs on the order of a million dollars to jump the regulatory hoops to gain approval for such markets, and I cannot say that this is not roughly the right cost magnitude.
For markets whose main function is to collect info, however, the appropriate scale seems far smaller. To collect info on a topic, those who know or could find out need only be offered a sufficient incentive to bother. In the lab, experimental economists see substantial effort and price info aggregation when only a few tens of dollars are at stake, and field data seems consistent with this estimate. If most of the social value from info-motivated event markets were concentrated in a few very important topics, it would not matter much if regulatory barriers prevented markets on topics with small info values. But if, as seems more plausible, much of the value is found in a long thick tail of smaller topics, then to realize this social value it is essential that regulatory barriers to creating such markets be reduced to the lowest feasible level.
For example, consider a topic where a social value of one thousand dollars could be realized, if only people were allowed to trade in a market on that topic. It is hard to see how this value could actually be realized if the regulatory cost to create this market were more than a few hundred dollars. If there were a million such topics, the total social value such markets could create would be one billion dollars.
A related difference is when it makes sense to limit participation. If most of a certain kind of risk is held by wealthy individuals or large organizations, then it can make sense to limit participation to such traders. But for info collection it is crucial to allow participation by the sorts of people who could plausibly obtain that info. For a great many topics these people will be spread out in the population, and not easily distinguished from most other people. A broad permission to participate will thus be desired in such cases.
How Can We Distinguish When This Regime Should Apply?
On the second question, we seek a reliable way to distinguish markets where the info collected is a strong rationale for its existence, a rationale strong enough to justify overturning the usual public presumption against generic speculation, and strong enough relative to hedging rationales to justify using this new regulatory regime, rather than other hedging regulatory regimes.
One proposed distinguishing criteria includes the size of an individual trader’-s stake, and the number of traders. The Iowa Electronic Markets are limited on both of these parameters. Such limits do succeed in preventing large hedging markets from masquerading as info-motivated event markets. But they do little to prevent generic gambling markets from masquerading as info-motivated event markets.
Another proposed distinguishing criteria is the form of the organization that hosts the market. Some have proposed that tax-exempt, research, and government organizations be given wider latitude than for-profit businesses. I understand that this matches a common public perception, but honestly it seems mostly wishful thinking to believe that such organizations are substantially more likely to create markets with a strong info rationale, or to avoid whatever problems one fears with
for-profit businesses.
Some have suggested that topics could be used to distinguish the strength of info rationale. Markets on sporting events might be presumed to have low info rationale, while markets on public policy might be presumed to have high info rationale. This approach seems to open a proverbial “-can of worms,”- however, requiring a great and continuing effort to categorize topics.
To ease this effort, one could inherit some other topic categorization. For example, regulation of speech distinguishes topics where free speech is presumed to perform very valuable social functions, and so has strong legal protection, from topics where such functions are less clear, allowing speech to be more easily regulated. Event markets might be permitted on topics where free speech has a strong legal protection.
In contrast to such weak indicators let me propose a stronger indicator of when a speculative market has a strong info rationale. I am not proposing that only markets which sport this indicator be allowed, but rather that at least such markets be allowed. My proposal is to permit markets where a sponsor pays to ensure that traders on average do not lose financially from participation, as this payment creates a strong presumption that this sponsor expected to gain substantial value from that info.
It is hard to see many of the benefits that traders may gain from trading, but we can more easily see the average financial costs that traders suffer. Traders may have to pay for permission to trade, to deposit into a system, to check prices and trading history, for each trade, and to withdraw their winnings. In addition, trader deposits may not earn competitive risk-adjusted rates of return. Payment is sometimes in the form of seeing ads. Such fees are essential to the profitability of “-gambling”- businesses today that rely primarily on traders’- speculative motives.
If for a particular topic, a sponsor were willing to ensure that traders paid none of these common trading fees, that sponsor would have credibly suggested that his or her market would not exist if that sponsor did not expect related info to have substantial value. If this sponsor furthermore subsidized this market, allowing traders to gain on average by trading against ignorant automated market makers, this would show even more clearly that this sponsor valued the resulting info. Such measures would ensure that traders suffered no average financial loss from their participation, though traders could still lose on average, such as by wasting too much time dealing with these markets.
Of course we do not expect sponsors to arise to support all topics where info collected by trading would have substantial social value. We expect businesses to sponsor markets on topics where they can profit from info, and charities to collect donations to support markets on topics they consider more broadly valuable. But we also expect many coordination failures, where each party prefers that others pay for commonly valuable info. So the case for prohibiting markets that fail my proposed criteria is much weaker than the case for permitting markets that meet this criteria.
It also remains possible that even when a sponsor finds info to be valuable enough to pay for, the social value of that info could be much less than the private value to this sponsor. If we could identify classes of such cases, these classes might form the basis of exceptions to this general permission I propose.
I have many other opinions about how such markets might be defined and regulated, but I’-ve already gone one for quite a bit here – if you like what you see here and want more, you know where to find me.
In Summary
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.
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Robin Hanson [email protected] http://hanson.gmu.edu
Research Associate, Future of Humanity Institute at Oxford University
Associate Professor of Economics, George Mason University
MSN 1D3, Carow Hall, Fairfax VA 22030-4444
703-993-2326 FAX: 703-993-2323
Robin Hanson
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BusinessWeek:
In its request for comment, the CFTC reminded the public that the commission should “-promote innovation for futures and derivatives.”- It also added that —hint, hint— the Iowa markets have been valuable sources of public information and have predicted Presidential outcomes better than polls. The 2000 act gave the CFTC the authority “-to promote responsible economic or financial innovation”- by creating an exemption for certain types of contracts (such as one in a prediction market). […]
“-Basically I think they’-re going to expand the IEM no-action letter and take legal measures to make sure that legal contracts aren’-t subject to antigambling laws,”- says Chapman law professor Bell. […]
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BusinessWeek gets it right about where the CFTC is going. (Go reading the 2 pages.)
However, I still believe that HedgeStreet has a strong argument (about the political elections being “-excluded commodities”-) and I wonder what the CFTC will do about it.
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Tom W. Bell:
The CFTC should not limit “-no action”- status to markets run by tax-exempt organizations. The no-action letters that the CFTC issued to the IEM emphasized not the nature of the hosting institution, the University of Iowa, but rather the business model adopted by the IEM itself. Profitability could not have mattered, as tax-exempt organizations can and do earn profits (indeed, as their burgeoning endowments demonstrate, many universities earn immense profits). The CFTC apparently cared only that the IEM did not plan to profit from charging traders commissions. A tax-paying organization could satisfy that condition just as easily as a tax-exempt organization could. In either event, price discovery would flourish and consumers would win a safeguard against getting fleeced.
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– The American Enterprise Institute’s proposals to legalize the real-money prediction markets in the United States of America
– In the for-profit vs not-for-profit debate, our prediction market luminaries, doctored by Bob, are on the wrong side of the issue.
– The definitive proof that FOR-PROFIT prediction exchanges (like BetFair and InTrade) are the best organizers of socially valuable prediction markets (like those on global warming and climate change).
– Analysis of the HedgeStreet’-s comment sent to the CFTC.
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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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Update: I’-ve extended the deadline for signing up until 7 p.m. Pacific, Sunday, July 6. Also, I fixed a typo in paragraph 3, changing “-denying”- to “-giving.”- (Thanks, Gil!)>-
The deadline looms for interested parties to respond to the Commodity Futures Trading Commission’-s request for comments about regulating prediction markets (”-event markets”- in the CFTC’-s usage). I may or may not get around to a detailed, point-by-point response to the CFTC’-s many questions. In the meantime, though, I’-ve drafted a general statement that many of you might agree with. I invite you to sign it with me, so that together we might tell the CFTC where to go. Please see below for details on how to sign on. Here is the draft statement:
What regulatory treatment should the Commodities Futures Trading Commission (”-CFTC”-) apply to event markets? We the undersigned, who represent a wide range of viewpoints, agree on three general observations. First and foremost, the CFTC should do no harm. Second, at a minimum, the CFTC should make more general the sort of “-no action”- status enjoyed by the Iowa Electronic Markets (”-IEM”-). Third, if the CFTC decides to regulate event markets more substantively, it should adopt clear and limited jurisdictional boundaries and allow affected parties to step outside of them.
First, do no harm: Many sorts of event markets—including public ones, private ones, ones that offer only play-money trading, and ones that offer real-money trading—already thrive in the U.S. They have provided a rich array of benefits without evidently harming anyone. The CFTC could help event markets achieve still greater success by clarifying their legality. Instituting the wrong sort of regulations could suffocate event markets in their cradle, however. The CFTC should exercise a light hand, taking care to do no more than offer qualifying event markets the shelter of federal preemption and freeing them to continue operating under the extant legal regime.
Second, open up the “-no action”- option: Thanks in part to the “-no action”- letters that the CFTC has issued to it, the IEM has for many years benefited the public by offering real-money event markets. No sound reason precludes the CFTC from giving similar treatment to other institutions that, like the IEM, offer event markets solely for academic and experimental purposes and without imposing trading commissions.
Although the CFTC’-s “-no action”- letters do not specify the exact criteria the IEM had to satisfy, they took favorable note of the IEM’-s account limits. Those account limits effectively prevent the IEM from supporting significant hedging functions. If the CFTC builds a similar requirement into any general “-no action”- guidelines, it should adopt limits considerably more generous than the meager $500/trader limit adopted decades ago by the IEM. Even a limit ten times that amount would still effectively preclude hedging.
The CFTC should not limit “-no action”- status to markets run by tax-exempt organizations. The no-action letters that the CFTC issued to the IEM emphasized not the nature of the hosting institution, the University of Iowa, but rather the business model adopted by the IEM itself. Profitability could not have mattered, as tax-exempt organizations can and do earn profits (indeed, as their burgeoning endowments demonstrate, many universities earn immense profits). The CFTC apparently cared only that the IEM did not plan to profit from charging traders commissions. A tax-paying organization could satisfy that condition just as easily as a tax-exempt organization could. In either event, price discovery would flourish and consumers would win a safeguard against getting fleeced.
Third, preserve regulatory exit options: If the CFTC decides to write substantive regulations for event markets, it should recognize and guard against the risk of overregulation. Even well-intentioned and well-informed regulators remain human and, thus, all too apt to make mistakes. They run an especially large risk of making mistakes when they first attempt to regulate new institutions, such as event markets. To make matters worse, regulators typically lack reliable signals to determine when they have gone too far. Industries wither away for many reasons, after all.
The CFTC’-s approach to regulating event markets should accommodate these policy considerations by establishing clear jurisdictional boundaries and opening exit options. Thus, for instance, the CFTC might specify that it has no jurisdiction over event markets that offer trading only to members of a particular firm, over markets that offer only spot trading in negotiable conditional notes, or over markets that do not support significant hedging functions. Then, if the CFTC enacts unduly burdensome regulations, an event market could opt out of them by changing its business model. So long as markets publicly announce that they operate outside the CFTC’-s purview, allowing them that freedom of exit would harm nobody. To the contrary, it would help the CFTC gauge the suitability of its regulations and serve the public by protecting the continued viability of event markets.
Interested in signing on? Please drop me a private email (tbell at chapman dot edu) with your name, institutional affiliation, and snailmail address. I welcome your comments—I’-m sure a typo or two persists in my draft—but I of course cannot revamp the entire statement without mucking up the entire process. To leave me time to get everything together and out the door before the July 7 deadline, you’-ll have to contact me before noon Pacific time on Sunday, July 6.
[Crossposted at Agoraphilia and Midas Oracle.]
[This article is cross-posted from Major Wager.]
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A recent article in the prestigious academic journal Science (May 16, 2008, Vol 320, p. 877-8) once again makes the case for regulated prediction markets, more commonly known as “-betting exchanges”- to online gamblers. The authors make the case that such markets are useful in forecasting future events with less error than traditional measures such as polling. This argument is hard to ignore, with the authors including 21 top economists from such esteemed institutions as Yale, Stanford, Berkeley, and the University of Pennsylvania. Notable among the authors is Justin Wolfers from the Wharton School of business at UPenn, an economist who has gained notoriety in gambling circles due to his work on such topics as NBA referee bias (highlighted in a May 2008 article from MajorWager: http://www.majorwager.com/index.cfm?page=27&-show_column=660).
The concept behind using prediction markets as a decision-making tool is simple. “-Shares”- are made available on an open market, and the participants use their capital (and the promise of profits) to make predictions on future events, which is incorporated into the share price. In general, information tends to be widely dispersed, and a market allows wide-ranging opinions to be gathered and consolidated into a market-wide prediction. In other words, an infinite amount of opinions can be aggregated, and an open market with potential for profit provides an incentive for individuals to make their opinions publicly known.
Prediction markets always get more than their fair share of press near the end of the 4-year U.S. Presidential election cycle. The Iowa Electronics Market, housed at the University of Iowa, is perhaps the most well-known. The authors of the Science paper show that, in the week immediately preceding the Presidential elections from 1988 through 2000, the Iowa Electronic Markets erred by an average of only 1.5 percentage points from the actual vote results, while the traditional Gallup poll was off by 2.1%. Numerous other studies have shown the superiority of markets compared to other forecasting tools.
Of course, there have been some dust-ups regarding prediction markets in the past, most notably the “-terrorist strike market”-, unveiled a little too close to 9/11 to be palatable to the general public. The official name was the “-Policy Analysis Market“-, and it was established by the Pentagon to act as a prediction market for Middle East political events. It was quickly scuttled after heated comments from U.S. Senators, calling it “-grotesque”- and “-stupid”-, due to the perception of using catastrophic events such as assassinations as profit-making tools. Regardless of its political correctness (and the misinformed opinions of a few politicians), such a prediction market still holds value as a glimpse into the collective mindset of everyone with an understanding of political currents in the region. Utilizing such a prediction market as a component of foreign policy decisions may have ultimately spared the U.S. much grief in Iraq.
In recent years, prediction markets have grown beyond academic and government roles. Dublin-based InTrade is rapidly growing and provides many more options than the Iowa Electronic Markets. Others such as MatchBook have focused more on sporting contests, but provide coverage of other events as demand calls. Of course, those outside the U.S. have access to the largest betting exchange of them all, the massive European markets of BetFair. The success of these exchanges speaks to the public interest and feasibility of prediction markets.
One factor holding back the growth of online prediction markets is their close association with the quasi-legal world of sports betting and internet casinos. InTrade has been fairly proactive in this regard, spinning off from Tradesports to clean up its corporate slate, but it is still knee-deep in the legal sludge surrounding offshore “-gambling”-. All have to deal with the legal and financial hurdles of operating offshore.
The authors of the Science paper propose that clarification of internet gambling laws is needed to exploit the benefits of prediction markets within the United States. Clearly, the Unlawful Internet Gambling Enforcement Act (UIGEA) of 2006 is one such mechanism restricting the widespread use of prediction markets. Another is the Commodity Futures Trading Commission (CFTC), the regulatory agency which oversees futures markets in the U.S. The CFTC has provided a “-no-action letter”- to the Iowa Electronic Markets, an assurance that they will not seek any enforcement action against the exchange. However, this protection is not absolute and may not trump state and federal law if challenged. The Science authors propose a number of legal reforms which will allow prediction markets to begin to gain acceptance within the U.S. financial regulatory structure.
By no means does the Science article condone large-scale public markets, at least not initially. They take a (typically academic) conservative approach, recommending new legal framework to allow for the establishment of small markets with limited scope so as to evaluate the promise and use of prediction markets. But baby steps are going to be a necessity in the growth and acceptance of regulated public markets.
Clearly, there are negative aspects to financial markets, and regulation certainly has its place. Bear Sterns, Enron, the S&-L scandal of the 80s, and the current housing bubble all caused tremendous loss of wealth resulting from missteps in the financial markets. The current oil crisis is due at least in part to speculation, leading to the introduction of no less than 9 separate bills in the U.S. Congress seeking tougher regulation over the trading of commodities. However, the existence of problems in the financial markets does not necessitate their dissolution. Likewise, prediction markets are sure to encounter bumps in the road, but their utility should far outweigh the risks.
Should prediction markets be legalized in the U.S.? Almost certainly. They would have benefit across numerous industries, from business decisions to political policies to financial forecasting. Unfortunately, this would require building an unlikely bridge over the Puritanical moral moat placed around gambling in the U.S. But there is no inherent difference in betting on who will win in an election than what the price of oil will be in 6 months, or what the S&-P 500 will close at on a particular date. Distancing prediction markets from “-illegal”- gambling, and instead likening them to regulated financial markets, will be a necessary first step towards broader acceptance.
The academic groundwork on prediction markets has already been laid, and offshore exchanges have begun to turn these concepts into functioning businesses. As these markets grow and begin incorporating more diverse opinions, we can expect their success rate at predicting the future to only grow. To restrict such a promising tool simply due to its perception that it is a gambling outlet is silly indeed.
6-25-08
Jay Graziani
MajorWager.com
[email protected]
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[This article is cross-posted from Major Wager.]
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