OSLO -- Last July a small scandal broke in Washington.
Admiral John Poindexter, of Iran-Contra fame, had been responsible for
planning a government-controlled online futures market, the Policy
Analysis Market (PAM). The purpose was to collect information on
political risks in the Middle East and worldwide. Commentators and
politicians jumped on the idea that some of the potential contracts
could involve terrorist attacks or assassinations, and dismissed the
possibility that someone should be able to profit from correctly
predicting such attacks as obscene.
Ironically, just a few days after the story broke, TradeSports put up a futures contract on Poindexter getting sacked before 30 August 2003.
TradeSports is the leading Irish online futures market, also known as a
betting exchange. Perhaps Poindexter would have been well advised to
seek cooperation with TradeSports or the other main player, the British
company Betfair, instead of
establishing a new marketplace. After all, the pervasive political
correctness that killed PAM seems to be a lesser problem in Britain and
Ireland, where regulation of internet gambling also is much less
restrictive than in the U.S. Instead of establishing their own
marketplace at an initial cost of US$8 million, Poindexter could have
paid the existing ones a trifle to set up betting lines of particular
interest.
Over
the last couple of years a number of such exchanges, where buyers and
sellers for financial, political, legal and sports futures are matched,
have sprung up. Political betting has been around for a long time, but
the betting exchanges are far more sophisticated than the old
bookmakers, even in their new online appearance. The commissions
charged, typically 3-5 percent, are much more advantageous than the
average bookmaker's payback-rate, usually in the 80-90 percent range.
The exchanges offer constantly changing prices, instantly reacting to
new market information, and are open 23 hours a day, every day. You
also have the opportunity to bet against an outcome, and above all, to move in and out of positions.
The
range of political bets is quite astonishing. Combining TradeSports and
Betfair, you currently can bet on the U.S. presidential election,
including VP nominee and winner in every single state, control of the
Senate and House of Representatives, British, Canadian and Australian
parliamentary elections, Tony Blair staying on as Labour party leader,
bin Laden being captured or killed, the sacking of George Tenet or
Donald Rumsfeld, U.S. Security Alert Level (perhaps a proxy for
terrorist attacks) at the end of every single month for the rest of the
year, the transfer of power in Iraq, the establishment of a Palestinian
state and Israeli eviction of Arafat.
Besides
the obvious entertainment value, the betting exchanges are information
accumulators. Like all efficient future markets, they combine available
information and sentiments to provide a snapshot of the likely future
outcome. Whenever the U.S. troops have a particularly bad day in Iraq,
Bush stumbles badly in a speech, the employment data are surprisingly
good or new opinion poll data are released, the market price for Bush
contracts moves. For those to busy following all the news, just
checking the TradeSports homepage gives you an instant update on the
state of the Bush campaign. This is the first thing Karl Rove should be
doing every morning! It is interesting to note that The Economist has begun referring to the TradeSports markets at a regular basis when covering the U.S. election campaign.
For
most of last year, the chance of a Bush victory fluctuated around 65
percent, peaking above 72 percent after the capture of Saddam. It has
been falling almost constantly thereafter, and has recently been
stabilizing above 55 percent. The Democratic nomination contest was a
kind of a roller coaster ride, but the Kerry momentum was identified
early on. Even after Kerry's nomination seemed secure, a possible
"bimbo eruption" in February created a short-lived fall in the market
and thus a profit opportunity for the cooler heads -- and a possibility
to cash in most of the winnings for the fainthearted.
The Iowa Electronic Markets (IEM) has been around since 1988, mostly predicting the outcome of U.S.
Presidential elections and other elections worldwide. This market has
in general been considered more reliable than opinion polls and
pundits. There is even research
to prove that the IEM, as it stands close up to the elections, is
better at predicting the outcome than the latest opinion polls. The new
betting exchanges should be even better, given that liquidity is
higher, and that real money is involved. The Iowa
market is more of an academic exercise, where no punter is allowed to
carry an account balance above US$500. It is reasonable to believe that
many participants in such markets lack the discipline that comes from
risking non-trivial stakes. Even so, IEM and TradeSports markets seem
to follow each-other quite closely.
Officially
the reasoning behind the DARPA (Defense Advanced Research Projects
Agency) project headed by Poindexter was to generate useful information
about the general political situation. A more troubling motive might
have been to lure people with inside information about a particular
incident, perhaps even terrorists themselves, to try to make a buck on
this information, and then try to identify the punter. If we are to
believe the official story, this was not the case, and the transaction
limit of $100 seems to prove this, as such an amount would hardly be
enough to motivate a terrorist. Anyway, using a futures market to
collect information on such low probability occurrences as the timing
and target of terrorist attacks or assassinations will probably not
work. There is just too little relevant information around to form a
basis for anything more than guesswork. This is also the verdict of the
marketplace -- no such contracts have been offered.
Even
so, there is nothing in principle that prevents a futures market to set
up contracts that many would find morally troublesome. The most serious
critique is that the existence of such a market, given sufficient
liquidity and therefore potential profit, could create incentives to
influence the outcome. This problem is well-known from sports betting,
where match fixing is not uncommon. One strategy in preventing this is
to exclude punters that might have a direct influence on the results,
or as a minimum to be able identify them after the fact. TradeSports
could not have accepted John Poindexter betting on his own departure,
as he had some discretion in the precise timing of this outcome.
Another measure is the one proposed by PAM and being the rule at IEM --
to put a low limit on the maximum bet, with the corresponding possible
efficiency loss mentioned above.
Another
safeguard would be to disallow betting on an extremely unwelcome
outcome, such as a terrorist attack or the assassination of the
American president. But as we have seen, people might differ on what
such an unwelcome outcome is. TradeSports actually has put "prices on
the heads" of both Saddam and bin Laden, and it easy to image an Arabic
betting exchange putting up contracts on Ariel Sharon. The potential
winnings on these contracts have of course been much smaller than the
actual bounty the U.S administration placed on the capture of Saddam,
and the bounty Al Qaeda conceivably has placed on the head of George
Bush. To create incentives for people to really try to influence the
outcome, the betting exchanges must increase potential winnings,
perhaps by a factor of 100. Even then, the chance of terrorists
actually playing these markets, given the high detection risk, must be
considered miniscule. Better then for a terrorist to bet by proxy in
the financial markets for stock or oil futures, or why not sell
Continental Airlines short? After all, there have been unconfirmed
rumours that Al Qaeda operatives shorted stocks on the New York Stock exchange before 9/11.
Although
betting exchanges can be quite efficient as information accumulators
even though liquidity is low, liquidity has to increase by several
orders of magnitude if these markets were to fulfil another potential
role, as risk management tools. If you are concerned that a Kerry
victory in the fall will raise your taxes or cause a general downturn
in the economy and hurt your business, you can insure against that by
buying Kerry contracts. Total turnover on TradeSports presidential
contracts are still less than US$4 million, and even if you add the
unknown millions placed at old-fashioned bookmakers, this market is
obviously still dominated by players that try to outguess other
players, not by risk managers. It is conceivable, but highly unlikely,
that these markets could grow so much that they could play a role in
risk management. If that was to be the case, the need for safeguards
against those who can influence the outcome would become acute.
And
in case you wondered: The chance of getting bin Laden before the end of
the year is about 30 percent, and the prospects for a Palestinian state
at the end of 2005 looks grim, at 15 percent.
