Thursday, May 10, 2007

Safe Harbor for Prediction Markets

A group of distinguished economists wrote a public letter advocating a legal safe harbor for some small-scale academic prediction markets. I can see why they limited their goals as they did, and I agree that everything they advocated should be legal, but I think they may have limited their objectives just enough to prevent any big wins.

One thing that Prediction Market maven Chris Masse constantly argues is that Prediction Markets on dry subjects need to be accompanied by entertaining questions in order to to keep the audience's attention. The economists had good reasons for shying away from recommending that sports betting should be included, but there are many other topics that diverse markets could include that give traders a reason to check back in. The range from the obvious entertainment questions (movie earnings and oscar winners) to legislative outcomes (bills passing and control of particular legislative bodies) and introduction and market success of new technologies. While these kinds of questions might be out of place on some single-topic markets modelled after the University of Iowa's markets on elections, the internal corporate markets that they also mentioned often use them to help maintain interest. The letter's recommendations that the CFTC "allow contracts that price an economically meaningful risk or uncertainty" unnecessarily limits the kinds of contracts that would be allowed.

Back on the side of supporting the letter's authors again, I'd have to admit that if the CFTC or Congress acts to implement anything resembling the recommendation it would very likely increase Prediction Market activity greatly, and eventually lead to a broader acceptance. If the initial definition is too narrow, however, questions that don't have clear economic implications (in the view of Congress and the regulators) might be stuck offshore for a long time to come.

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