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Toward
A Bettor Future By Steven M. Cherry
A U.S. government betting pool for future terrorism events is gone, but predictive
markets are here to stay
8 August 2003—The
hue and cry over the Policy Analysis Market, a recently revealed
and quickly canceled U.S. Department of Defense research plan
to use a futures market to help it predict terrorism events,
has obscured a couple of important facts. Similar markets
have been used for years to predict everything from the next
U.S. president to the toppling of Saddam Hussein, and generally
they have had excellent track records.
The Policy Analysis
Market, or PAM as it’s funding parent, the Defense Advanced
Research Projects Agency (Darpa; Arlington, Va.) calls it,
has been taken too seriously by some and perhaps not seriously
enough by others. Quickly quashed after a drumfire of disdain
from the U.S. Congress, the idea of a terrorism futures market
reappeared in civilian form as the American Action Market
[http://www.americanactionmarket.org].
But that Web site, despite being taken at face value by media
outlets like Wired News, could be merely a parody of
PAM. Evidence points to connection to the creators of a well-known
political spoof site, gatt.org.
It’s
too bad that the idea of futures markets is not given enough
level-headed thought. The PAM project certainly had a creepy
feel to it, studying as it did things like whether or not
specific Middle Eastern prime ministers would be assassinated.
But financial markets have always served an important role
in the economy—their ability to aggregate opinion and
forecast the future. For example, the futures market for oil
is the best predictor economists have of that vital commodity’s
future price.
PAM’s
predecessors
On-line
predictive markets like PAM have long been used to predict
future prices, trends, and events such as elections. Months
before PAM hit the news, the Irish betting site, Tradesports.com
[http://tradesports.com/],
had been taking wagers on an event of great interest to the
Defense Department: when Saddam Hussein would be deposed.
The granddaddy
of online predictive markets, one that has been accurately
foretelling U.S. presidential election results since 1988,
is the Iowa Electronic Markets (IEM), run by the University
of Iowa’s Tippie College of Business in Iowa City [http://www.biz.uiowa.edu/iem/].
It consistently beats the polls at predicting election results.
This shouldn’t be as surprising as it seems, since polls
aren’t a test of who will win but, rather, a measure
of how the electorate would vote at the time of the poll.
The IEM,
on the other hand, is targeted at the actual election. There
are two forms of wager. In the first, called a vote-share
market, a contract pays off at US $1 multiplied by the relative
share of the vote. Thus, a trader who thinks a candidate will
get 40 percent of the vote will be willing to buy the contract
at $0.39 or lower, but not $0.41 or higher.
The other
type of contract, winner-take-all, gets a similar result by
a different means. The contract will pay $1 or nothing at
all, based on who wins the election. But traders can value
the contract however they want. Those who think there’s
a 40 percent chance of a particular candidate winning feel
they are getting a bargain at any contract price up to and
including $0.39. In the IEM, real money exchanges hands, though
the amounts are $500 or less as part of an agreement with
the Commodity Futures Trading Commission (Washington, D.C.).
Markets
such as these "act as complex, dynamic, interactive systems
that incorporate information in new ways," according to "Accuracy
and Forecast Standard Error of Prediction Markets," a paper
written by Joyce Berg, Forrest Nelson, and Thomas Rietz, three
of the University of Iowa faculty members involved in IEM.
Says Berg: "There’s lots of research in experimental
economics that says markets are good at aggregating information."
The Iowa
group and others have found that IEM traders with more information
do well. Those without, like poorly skilled poker players,
provide the profit that the better players walk away with.
(As an old adage in poker puts it: "If you can’t tell
who at the table is the sucker, it’s you.")
Berg and
her colleagues also acted as consultants for other Darpa market
experiments. "There has to be information to aggregate," she
says. "That’s the first question. So to run a market
like PAM, you’d want to include policy analysts, experts
in Mid-Eastern affairs. Specific people would be invited.
On the other hand, you don’t always know who has useful
information, so it might be a mistake to exclude anyone."
The Department
of Defense never said exactly how it would use the price-derived
information culled from PAM, but Berg says it’s easy
to see how such markets can serve government officials. For
example, Neoteric Technologies (Huntsville Ala.) had already
created similar, albeit more benign, markets, such as whether
and when SARS would reappear. Berg says, "A market like that
might help us decide how to invest research money and other
medical resources."
Independent
of its university affiliation, the Iowa group served as consultants
to Neoteric. Though funded by Darpa under a so-called Small
Business Innovation Research grant awarded in 2001, Neoteric
did not work on PAM itself. [See a description of their work
at http://www.neotek-al.com/markets/Neotek_Markets.html.]
Research on the PAM markets was done by Net Exchange (San
Diego, Calif.), a group that includes faculty from the California
Institute of Technology and George Mason University [http://www.nex.com].)
Likewise,
Berg notes that Tradesports, the Irish betting site, and her
group in Iowa as well, have run threat-level markets. Referring
to a U.S. government practice of assigning different colors
to different levels of danger from terrorists, she says that
one such contract might concern the number of days in a given
month that are Level Red. "That might help state and municipal
governments decide how to budget, or allocate emergency personnel,"
she says.
Gamblers
anonymous
There
just aren’t many tools out there for predicting events
like coup d’etats and assassinations. The main one is
called the Delphi method. Back in the early 1960s, Berg explains,
the U.S. government was trying to find ways to aggregate expert
opinion. Researchers at RAND (Santa Monica, Calif.) found
that if you put a group of experts in a room and got them
talking, the loudest voice’s opinion usually wins.
To avoid
that, they tried using anonymous questionnaires. They would
then report to the members of the group various statistics
from the survey, such as the median and the mean, and then
ran the survey again. The research says that after three or
four iterations, the opinions converge and serve to aggregate
the expert information.
Predictive
markets, Berg says, are also forums for communicating where
the loudest voice doesn’t win. A market transforms everything
into a single statistic—the price of a contract—and
conversations can start on whether that’s a good number.
Spoof
or oracle?
Creepy
as it was, PAM’s pedigree and potential value were lost
in the debate following its disclosure. Further precluding
any serious discussion, along came the American Action Market
(AAM) . It says it will create much the same markets PAM would
have. But despite AAM’s claim to have been founded by
a group of academics at some of the top institutions in the
United States, there are clues that it isn’t really a
serious attempt to create futures markets.
For one
thing, the examples of questions to be asked in the betting
pool, which were given in AAM’s founding press release,
don’t lend themselves to contracts. One was, "Which corporation
will be next to see its close relationship to the White House
erupt in scandal?" Another asked, "Was the invasion of Afghanistan
planned from the start as a stepping-stone to an attack on
Iraq?" isn’t even a question about the future. Futures
contracts need to be easily settled. That’s why they
ask crisp questions like "Will at least 100 000 people die
of SARS by the end of 2004?" rather than the vague "Will SARS
continue to be a threat?"
A look
at the domain name system record for americanactionmarket.org
is also revealing. (A public record of the owner is created
when a domain name is registered.) The site’s owner is
said to be Hedwig Ixtabal-Mono, a name that Google associates
with Gatt.org, an organization known for creating spoof Web
sites. While many such records have spurious data, it’s
an odd coincidence.
Bob Ostertag,
a San Francisco musician and freelance writer who is apparently
AAM’s spokesperson and public relations director, was
at a loss to explain the Hedwig Ixtabal-Mono name. When asked
whether the organization—unincorporated, with no physical
address, and a board of directors who refuse to reveal their
own names—is a real market or a spoof, Ostertag said,
"When we launched, it wasn’t clear it wouldn’t be
a goof, but it became clear that people were interested. It’s
become more real every day." He added, "Hundreds and hundreds
of individuals have sent e-mails wanting to become traders."
The
future of futures
Whether
AAM is a hoax or not, online predictive markets are here to
stay. Eric Zitzewitz, an assistant professor of economics
at Stanford University’s Graduate School of Business
(Palo Alto, Calif.), studied the Tradesports site, which,
before the U.S.–Iraqi war, included a market for whether
or not the war would be averted. "Probably about $1.5 million
traded hands" in the run-up to the war, he says.
Zitzewitz
compared the Tradesports market to the Standard and Poor’s
stock market index, since they both rose and fell during major
events like U.S. Secretary of State Colin Powell’s United
Nations presentation on Iraqi weapons of mass destruction.
"Tradesports incorporated the S&P information with lags
of only a half a day or so. The S&P is incredibly efficient,"
he says, "but without the fluctuations in the market price
concerning Saddam’s future [at Tradesports], you couldn’t
separate the war news from the general corporate and economic
news that affect the stock market."
Predictive
markets have also taken a particular hold in the entertainment
world. The Hollywood Stock Exchange [http://www.hsx.com/]
predicts the success of Hollywood movies, while at Celebdaq
[http://www.bbc.co.uk/celebdaq/]
one can bet on the popularity of Hollywood celebrities—what’s
measured is the number of times in a given month the individual
is named in the popular media. There’s also Fatdog Exchange
[http://www.fatdogexchange.com/],
where the notion of celebrity includes not just Britney Spears,
but Bill Gates and Bill Clinton.
Zitzewitz
thought the Policy Analysis Market might be useful, but only
if it could attract enough people with information to be successful.
He told me that having journalists participate would
help. "You could see journalists looking at a price, seeing
a 10 percent chance of an event, saying that’s probably
wrong, and buying a contract," he said. At last, I thought,
someone thinks I have the inside scoop. Plus, it could be
a way to make a little cash on the side.
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