The Boston Globe

                     August 3, 2003, Sunday ,THIRD EDITION

SECTION IDEAS; Pg. E5

LENGTH 432 words

HEADLINE BETTING ON TROUBLE

BYLINE By Joshua Glenn

BODY

   THE DEFENSE DEPARTMENT'S attempt to assess the likelihood of undesirable
events in the Middle East with a bettor's poll didn't pan out. But was there
anything to the notion of a "terror futures" market? Ideas telephoned the
Stanford economist William F. Sharpe, whose insights into the valuation of risky
assets transformed finance, earning him a Nobel Prize and the nickname "the
godfather of index funds." IDEAS Do you think the Defense Department's Policy 
Analysis Market might actually have worked? SHARPE Truly competitive markets,
in which no one has strong inside information, are certainly better predictors
than a group of "experts" reinforcing one another's opinions. None of us is as
smart as all of us, as they say, which is why the very idea of an index fund is
to "buy the market," or to use the average of other people's predictions. That
said, the proposed market wouldn't have been truly competitive because of its
sponsorship by the Pentagon. I'd worry that someone betting on when Weapons of
Mass Destruction will be discovered in Iraq might in fact already know where
such weapons are. It might work if someone were independently to set up a terror
futures market, but for the Pentagon to do so would be like setting up an office
pool on What We Do at the Office.  IDEAS Some critics claim that if a market
were to try to predict, say, how many terrorist attacks there will be in a given
month, it wouldn't benefit from the collective rationality of investors-because
terrorists act irrationally. SHARPE From what I understand, the idea of this
market wasn't to predict specific acts of terror-it aimed to measure political
and economic instability in certain regions. But it's not absurd to think that
such a market could predict the general likelihood of terrorist attacks. After
all, we bet on the nonrational, from natural events to box office results, all
the time.  IDEAS Do you have any moral objections to the Pentagon's plan?
SHARPE When I first heard about it on the radio, it struck me as unseemly-I don
't think I'd be willing to gamble on things like people being murdered. But lest
I seem purer than pure, I should point out that when one buys the market, one is
investing in things like airline stocks, which means marginally betting on
whether or not there will be another 9/11. Although this may be different in
degree from betting on the probability of terrorist attacks, it's not different
in kind. So even though I personally don't want to bet on whether or not Saddam
Hussein will be killed, I think others should be allowed to do so.

GRAPHIC PHOTO, According to index funds pioneer William F. Sharpe, American
investors already are gamgling on terrorism. / COURTESY FINANCIAL ENGINES INC.