WHEN GAMBLING IS GOOD
May 11, 2007
Prediction markets -- markets that allow traders to vote with their money on the future unemployment rate or the winner of the next presidential race, for example -- could improve decision making in a whole host of arenas. Yet regulatory restrictions imposed by federal and state anti-gambling laws make these markets risky to operate, say Robert Hahn, executive director of the AEI-Brookings Joint Center, and Paul Tetlock, professor of finance at the University of Texas at Austin.
- Prediction markets, or information markets, help forecasters, for example, by allowing traders to vote with their money on the future unemployment rate or the winner of the next presidential race.
- If you visit the Iowa Electronic Markets, you can take a financial position on the Democrats' chances of winning the White House in 2008.
- A contract purchased for $6.15 would yield $10 if a Democrat wins, allowing analysts to infer that the "market" believes they have a 61.5 percent chance of taking the election.
Many academics across the political spectrum are excited that prediction markets could improve decision making in a whole host of arenas. Unfortunately, regulatory restrictions imposed by federal and state anti-gambling laws make these markets risky to operate. As a result, there is a need for the creation of a safe harbor for small-stakes, not-for-profit prediction markets to encourage experimentation:
- One could, for example, introduce exemptions for research-focused markets in which the size of individual investments does not exceed $2,000 per participant.
- The Commodity Futures Trading Commission (CFTC) could provide this safe harbor in the form of a "no-action" letter; or alternatively, the commission could create formal guidelines that make it cheaper and easier to start these markets.
- The CFTC may want to restrict experiments that can potentially improve economic decisions or mitigate financial risks, but otherwise it should adopt a laissez-faire approach.
Source: Robert Hahn and Paul Tetlock, "When Gambling Is Good," Wall Street Journal, May 11, 2007.
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