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

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The Promise of Prediction Markets – by Kenneth J. Arrow, Robert Forsythe, Michael Gorham, Robert Hahn, Robin Hanson, John O. Ledyard, Saul Levmore, Robert Litan, Paul Milgrom, Forrest D. Nelson, George R. Neumann, Marco Ottaviani, Thomas C. Schelling, Robert J. Shiller, Vernon L. Smith, Erik Snowberg, Cass R. Sunstein, Paul C. Tetlock, Philip E. Tetlock, Hal R. Varian, Justin Wolfers, and Eric Zitzewitz – 2008-05-XX

#1. The Commodity Futures Trading Commission (CFTC), the federal regulatory agency that oversees futures market activity, should establish safe-harbor rules for selected small-stakes markets. One limited safe harbor is the no-action letter, in which the CFTC market oversight staff confirms in writing that it will not recommend enforcement action if the recipient acts in specified ways. The only prediction market to receive a no-action letter (in 1992) is the Iowa Electronic Markets, which is run by professors at the University of Iowa and which initially focused on presidential elections. Although such no-action letters reduce the chances of legal action under other state and federal laws, they may not be adequate. We would therefore urge the CFTC to explore other approaches to ensuring safe harbors, for example, formal rules or guidance approved by the commission. We suggest that three types of entities be eligible for safe harbor treatment. The first would be not-for-profit research institutions, including universities, colleges and think tanks wishing to operate exchanges similar to the Iowa Electronic Markets. The second would be government agencies seeking to do research similar to that of nongovernmental research institutions. The third group would consist of private businesses and not-for-profits that are not primarily engaged in research, which would only be allowed to operate internal prediction markets with their employees or contractors. In all cases, markets would be limited to small-stakes contracts. Although the definition of small stakes is somewhat arbitrary, we use the term to mean an exchange in which the total amount of capital deposited by any one participant may not exceed some modest sum, perhaps something like $2,000 per year. The exchanges themselves would be not-for-profit but would be allowed to charge modest fees to recoup administrative and regulatory costs. Brokers and paid advisers would be barred, reducing the risks that contracts would be sold to inappropriate or vulnerable customers or that customers would be charged fees above the amounts needed to maintain the markets. Exchanges would be self-regulated, leaving them with the responsibility to make reasonable efforts to keep markets free from fraud and manipulation. For its part, the CFTC should allow contracts that price any economically meaningful event. This definition could allow for contracts on political events, environmental risks, or economic indicators, such as those offered by the Iowa Electronic Markets, but would presumably not include contracts on the outcomes of sports events.

The contracts qualifying under this safe harbor would also create opportunities for more efficient risk allocation. Although the small-stakes nature of these markets would necessarily limit their usefulness for hedging risk, they could serve as proofs of concept for larger-scale markets that could be developed under alternative regulatory arrangements. The CFTC should allow researchers to experiment with several aspects of prediction markets – fee structures, incentives against manipulation, liquidity requirements and the like – with the goal of improving their design. Prediction markets are in an early stage, and if their promise is to be realized, researchers should be given flexibility to learn what kinds of design are most likely to produce accurate predictions. Of course, exchanges would need to inform their customers so that they are aware of the risks and benefits of participating in these markets.

#2. Congress should support the CFTC’s efforts to develop prediction markets. To the extent that the CFTC incurs costs in promoting innovation, Congress should provide the necessary funding. More fundamentally, Congress should explore alternative ways of securing a legal framework for prediction markets if the CFTC’s existing authority proves inadequate. In particular, Congress should specify that a no-action letter, or similar mechanism, preempts overlapping state and federal anti-gambling laws. Because Congress did not intend the CFTC to regulate gambling, it is important to design new regulations so that socially valuable prediction markets easily qualify for the safe harbor but gambling markets do not.

UPDATE: A great rebuttal here&#8230- :-D


– CALL TO ACTION: Let&#8217-s fight so that the CFTC allows the FOR-PROFIT prediction exchanges to deal with &#8220-event markets&#8221-.

– 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.


CFTC’s Concept Release on the Appropriate Regulatory Treatment of Event Contracts&#8230- notably how they define &#8220-event markets&#8221-, how they are going to extend their &#8220-exemption&#8221- 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 &amp- Porter lawyers explain the meaning of the CFTC&#8217-s concept release on &#8220-event markets&#8221-. &#8212- (PDF file)

– The Schulte &amp- Roth &amp- Zabel lawyers&#8217- takes. &#8212- (PDF file)

– The Sullivan &amp- Cromwell lawyers&#8217- takes. &#8212- (PDF file)

– What Vernon Smith told the CFTC.


Paul Wolfowitz&#8217-s profile at the American Enterprise Institute

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

The CFTC safe-harbor option for event markets

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The recommendation for safe-harbor of a group of influential economists to the CFTC aims squarely at the 4(c)3(K)* clause of the Commodity Exchange Act. The CFTC may approve a public interest exemption under 4(c) provided that the affected contracts are traded only between &#8220-appropriate persons&#8221-. 4(c)3(k) is the only qualification that would accommodate &#8220-retail&#8221- trading in the style of IEM, allowing, &#8220-Such other persons that the Commission determines to be appropriate in light of their financial or other qualifications, or the applicability of appropriate regulatory protections.&#8221- Regarding &#8220-other qualifications&#8221-, the economists recommend:

&#8220-that three types of entities be eligible for safe harbor treatment. The first would be not-for-profit research institutions, including universities, colleges, and think tanks wishing to operate exchanges similar to the Iowa Electronic Markets. The second would be government agencies seeking to do research similar to that of nongovernmental research institutions. The third group would consist of private businesses and not-for-profits that are not primarily engaged in research, which would only be allowed to operate internal prediction markets with their employees or contractors.

Regarding the applicability of regulatory protections, the economists recommend that such markets should be limited to small-stakes, low-fee contracts. This limitation addresses consumer protection because the CFTC is typically much less interested in non-levered transactions, and there is little chance of being able to manipulate a market with a small-stakes account. Possibly, consumer protection measures could completely satisfy 4(c)3(K).

The safe-harbor proposal looks like an expedient option that would avoid the problems of treating event markets as excluded commodities (or exempt commodities), which were touched on last time. One problem the CFTC faces is selecting a principle that would include only markets that pass an economic purpose test within their jurisdiction, and the safe-harbor proposal avoids this problem. Although there doesn&#8217-t seem to be anything in the CEA to indicate that an exempted market could possibly lie outside the agency&#8217-s jurisdiction, Congress has determined – significantly – that, &#8220-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.&#8221-

Arguably, if someone were to set-up non-profit small-stakes exchanges similar to the ones the economists describe, they would not need CFTC safe-harbor anyway – especially if they restrict trading to States where the predominant factor test applies. Safe-harbor would, however, allow for exchange profits.

I believe that a combined approach would work best. Treating event markets as excluded commodities would not contradict granting some exchanges public interest safe-harbors, which would especially be appropriate if they wanted to host markets like research science claims, where a trader might be in control of the outcome. Exchanges seeking to host larger stake markets useful for hedging could do so with a trading prohibition for people who might be in control of the outcome. From the CFTC&#8217-s perspective, the safe-harbor would be a less complicated option with regard to their jurisdictional scope. Ultimately, statutory clarification is needed.

* This section is listed as USC Title 7, Chapter 1 6(c) here.

Cross-Posted from RM&amp-P

ROBIN HANSONS PUBLIC ADMISSION: He signed Bobs petitions, not because he heartfully endorsed them fully, but because he wanted to please Bob, didnt want to be left out of the party, and was persuaded that his own blue-sky proposals wouldnt make it -and other irrational excuses for not saying the tru

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Robin Hanson:

Hal and Silas, endorsing this proposal does not mean that I would not prefer other proposals- it just means I prefer this to the status quo. Chris Masse is an example of someone who has difficulty accepting this endorsement concept.


Why wouldn&#8217-t you:

  1. Gather with yourself and determine under what precise circumstances you want the real-money prediction markets (which you co-invented with the IEM people) to flourish in your country-
  2. Then, consult with your peers (Wolfers et al.) on whether they&#8217-d agree with you-
  3. Publish a petition that lays out how the real-money prediction markets would blossom in America-
  4. Add, at the bottom of that petition, an appendix laying out what would be, for you, an acceptable Plan B-
  5. Hummmm&#8230-.??&#8230- Sounds more logical to me.

Previous blog posts by Chris F. Masse:

  • Prediction Markets
  • Meet professor Justin Wolfers.
  • Become “friend” with me on Google E-Mail so as to share feed items with me within Google Reader.
  • Nigel Eccles’ flawed “vision” about HubDub shows that he hasn’t any.
  • How does InTrade deal with insider trading?
  • Modern Life
  • “The Beacon” is an excellent blog published by The Independent Institute.

Robin Hanson would be better off lobbying for prediction markets with the people who will be in power next November -that is, the Democrats, not the right-wing people of the American Enterprise Institute.

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Does Robin Hanson read the political prediction markets which he co-invented? If he read them, he would see that we&#8217-re going to get a big Democratic swipe, in November 2008. The American people will get rid of the neo-cons, the warmongers, and other right-wing nuts.

Then, if you wanted to &#8220-lobby&#8221- for the prediction markets, you would get your message thru using either a Democratic or bi-partisan vehicle &#8212-not the right-wing American Enterprise Institute. What weight will those right-wing people carry next November? They&#8217-ll be finished &#8212-until a brand-new Newt Gingrich alike pops up in the years 2020.

Get a ride in K Street with the right people, doc &#8212-that is, in our case, like it or not, the leftists.