Prediction markets didnt revolutionize decision-making -and will never do. However, they are a nice condiment to the classic forecasting toolkit.

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I have spent several hours re-reading the 2004 AEI-Brookings book, &#8220-Information Markets&#8221- (by which they mean &#8220-prediction markets&#8221-). It is a collection of un-enlightening research articles &#8212-except for the IEM article, which is outstanding, both on the factual and theoretical sides.

In the conclusion of their introduction, Robert Hahn and Paul Tetlock wrote that they want their readers to contemplate the idea that prediction markets could make a &#8220-big&#8221- difference and &#8220-revolutionize public- and private-sector decision-making&#8221-. Well, 4 years later, it is clear that those big dreams didn&#8217-t pan out. Not a single mass media outlet has praised the public prediction markets for their work on the 2008 US presidential election (I am taking about a post-mortem analysis about Election Day, not the primaries). Not a single one. (Not even Justin Wolfers.) And the number of corporations using enterprise prediction markets is still minute. The thinkers who wrote this book (&#8220-Information Markets&#8221-) all made the mistake to put the emphasis on accuracy instead of efficiency. That was the foundation flaw. We should reset and reboot the field of prediction markets.

Previously: The truth about prediction markets

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


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Freakonomics, the famous blog on economics, is powered by WordPress, which is known [*] to have grave security vulnerabilities. Yesterday, a dangerous hacker managed to get access to their blogging software, and published an opinion on the regulation of prediction markets, which represents the total opposite of what Steve Levitt believes in. No doubt the hacker (who signed as &#8220-The Australopithecus&#8220-) will get caught by the Police. No doubt Steve Levitt will get out of his torpor soon and re-establish the truth. We will then give airtime to Steve Levitt&#8217-s arguments, on Midas Oracle. We&#8217-re with you, doctor Levitt.

[*] I know that for a fact. Midas Oracle was hijacked yesterday by a dangerous hacker who signed as &#8220-The Barbecue&#8221-. I&#8217-m not responsible for what he said.

A historical Robin Hanson fanboy cant believe his hero signed Bobs ill-informed and unwise petition.

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Hal Finney:

My concern is that the small stakes limit of $2,000, the limits on who can operate markets, and the limitations on the scope of markets, will lead to spotty coverage which will preclude a robust evaluation of the merits of prediction markets in general. After all, we have already which provides spotty coverage of a number of issues – how much more will this add?

Maybe &#8220-gambling can save science&#8220-, but I don&#8217-t see how these steps would show it.

Proof that you can be &#8220-high IQ&#8221- and still lack judgment (in small ways).

P.S.: Over that the micro slam above, I have the highest esteem and respect for Robin Hanson &#8212-a prediction market pioneer.

BetFairs Annual Review 2006: How did the worlds #1 real-money prediction exchange (betting exchange) fare in 2005/2006?

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Pretty good, thank you. British betting expert Niall O&#8217-Connor reports that &#8220-Betfair has announced that during the year to 30 April 2006, it recorded year-on-year revenue growth of 35 per cent to ?144.7 million, with profits before tax up to ?37.8 million from ?23.1 million in 2005, an increase of 63 per cent.&#8221-

More information: BetFair site – BetFair Corporate site – BetFair Annual Review 2006 (PDF)

Highlights of BetFair Annual Review (the sub-titles and emphasis are mine):

1. Unlike TradeSports/InTrade, BetFair does not break U.S. laws.

In light of recent events in the United States we continue to monitor the situation. We wish to reiterate our well documented and long-standing policy of not accepting US customers, funds, or bets. For many years, we have followed industry best-practice to ensure that we are able to detect and block unwanted usage.

My Remark: A small number of U.S. residents has managed to open an account with BetFair, I&#8217-ve heard, because they managed to prove some kind of residential or banking U.K. presence.

2. Compared to BetFair, TradeSports/InTrade and HedgeStreet look like kindergarten toys.

The size and scalability of the site is demonstrated by the fact that there were over 1.3 billion bets placed on the exchange in 2005, which is more than all the previous years’ totals added together. We now regularly handle over five million bets per day, serve two billion page impressions a week and more than ?2,000 a minute is deposited onto the site. We now employ over 900 staff across five main offices in West and North London, Denmark, Malta and Australia. While we are beginning to experience economies of scale in many operational areas, we continue to recruit heavily in IT, Product Management and International Development. These new hires will accelerate our product delivery and competitive advantage in the years ahead. Customer numbers are also impressive. In the past year we have doubled the number of registered customers, with over 900,000 by the end of the World Cup. The number of monthly actives increased from 95,000 to over 150,000 by April 2006 […].

My Remark: Two bets make up for one transaction, right?

3. Unlike TradeSports, BetFair has signed agreements with sports bodies.

We continue to work closely with a number of sporting regulators, notably in horseracing, football and tennis, which highlights the importance of our information sharing agreements. A series of &#8216-MoUs&#8217- (Memorandum of Understanding) have been signed with sports bodies over the year, including the Rugby Football Union, Women&#8217-s Tennis Association, International Tennis Federation, Belgian Football Association, British Darts Organisation, Racing Services Tasmania, Racing Victoria Limited and, most importantly in light of the World Cup, FIFA. This brings the total number of agreements we have with sports bodies worldwide to 24.

My Remark: Twenty four. Impressive.

4. Unlike TradeSports, BetFair has applied its trading technology to other applications.

The poker market is particularly competitive and therefore it is important that we expand our product portfolio and diversify our revenue streams. We acquired PokerChamps, a Danish-based poker platform, in October, and from August this year Betfair&#8217-s entire Games portfolio has been hosted from Malta. We will continue to invest and improve the product to make it the most exciting poker offering. The Games offering was also extended with the launch of Exchange Baccarat [CFM: and recently Exchange Hi Lo], complementing exchange versions of Poker and Blackjack. These unique exchange-enabled products offer further opportunities for customers and reinforce our reputation for innovation.

My Remark: I&#8217-m not (yet) persuaded that the BetFair Exchange Games is such a great killer ap. What I see is a small number of existing BetFair traders playing this stuff. In the coming months and years on this blog, I&#8217-m going to elaborate on the X Universes, which is a concept that extent much further. If you&#8217-re a universe creator, a techie, a VC or an exchange manager, stay tuned- the future will be fascinating in this area.

My Question To Robert Hahn And Paul Tetlock: Would your proposal, discussed in your paper and in your New York Times Op&#8217-Ed, allow for one or some U.S.-based real-money prediction exchange(s) as POPULAR AND PROFITABLE as U.K.-based BetFair?

NEXT: The BetFair 2007 Annual Review = 2007 Results (ending April 30, 2007) – (PDF file) –

Previous blog posts by Chris F. Masse:

  • Americans love rankings, but Americans hate to be assessed subjectively.
  • A libertarian view on the Internet betting and gambling industry in the United States of America
  • The CFTC is going to close the comments in 10 days. We have 10 days left to convince the CFTC to accept FOR-PROFIT prediction exchanges (e.g., InTrade USA or BetFair USA), and counter the puritan and sterile petition organized by the American Enterprise Institute (which has on its payroll Paul Wolfowitz, the bright masterminder of the Iraq war).
  • The Numbers Guy
  • The CFTC Readings Of The Day —Thursday Morning Edition
  • The CFTC is going to close the comments in 11 days. We have 11 days left to convince the CFTC to accept FOR-PROFIT prediction exchanges, and counter the evil petition organized by the American Enterprise Institute (which has on its payroll Paul Wolfowitz, the bright masterminder of the Iraq war).
  • 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).