St. Petersburg Times (Florida)

                 August 3, 2003 Sunday 0 South Pinellas Edition

SECTION FLORIDIAN; Pg. 1F

LENGTH 394 words

HEADLINE Placing bets on regime change

SERIES WORD FOR WORD

BYLINE CHUCK MURPHY

BODY

   On Monday, two U.S. senators disclosed that Pentagon officials were preparing
to allow a program that amounted to wagering on future terrorist attacks or
Middle East war. But the Pentagon description of the "Policy Analysis Market,"
was considerably less forthright than that. Rather than a place for profit from
terrorism, the market's Web site, which was killed along with the program on
Tuesday, made it sound like a confusing academic exercise in predicting the
future - for fun and money.

   - CHUCK MURPHY, Times staff writer

An Example of PAM Futures and Derivatives Contracts

   To illustrate the sort of contracts tradeable on PAM, consider two issues
tied to the now-historic case of pending hostilities between the United States
and Iraq (a) whether the Jordanian monarchy would be overthrown during
hostilities between the United States and Iraq; and (b) the ability of the Iraqi
regime to persist for more than one month of hostilities. Each of these issues
has two states; they occur or do not occur. A pair of futures contracts can
therefore be defined for each issue, and only one pair can end up as true

   + Assigning the shorthand A to the Jordanian issue, A means overthrow occurs
and (not A) means overthrow does not occur.

   + Assigning the shorthand B to the Iraqi issue, B means the regime persists
after one month of hostilities and (not B) means that it does not persist.

   To illustrate why such futures contracts would be traded, consider two PAM
traders a specialist in Jordanian domestic affairs and a specialist in U.S.
military planning and operational capabilities.

   The specialist in Jordanian domestic affairs may have a strong opinion that
should the Iraqi regime persist beyond one month, the Jordanian monarchy will
most likely fall. However, this PAM trader has no special knowledge of how U.S.
military capabilities compare to Iraqi capabilities, or how the U.S. military
intends to utilize its capabilities. For this trader, the conditional
derivative, or hedge, is quite powerful. The conditional derivative allows the
Jordanian domestic affairs specialist to leverage her knowledge of an effect (A)
by hedging against her relative ignorance of a cause (B). If the cause does not
occur, then she does not lose any money, but if the cause does occur and the
effect follows, then she can make a handsome profit.