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The Good Side of the Terror Futures Idea (Yes, There is One)
----- [Terror Futures Market, Terrorism Futures, Policy Analysis
Market, The Other Side, Opposing View, Alternative Perspective, David
M. Pennock, Information Markets, Prediction Markets, Insurance,
Hedging, Uncertainty, Risk]
Commentary: The Good Side of the 'Terror Futures' Idea (Yes, There is One)
Note: The opinions expressed here are my own, and do not necessarily
reflect the opinions or views of my company or any other person or
organization.
Given the uproar over the so-called terror futures market,
you might be wondering what those mad scientists at DARPA were
thinking. Believe it or not, there really is another side to this
story, though the initial media firestorm did not uncover it, as both
Democrats and Republicans with very cursory knowledge of the plan
tried to distance themselves as quickly as possible. In the aftermath,
several excellent commentaries and articles from well-known academics
and journalists have been written defending the market, or at least
the core ideas behind the market. Here are some voices on the other
side of terror futures issue, from...
The
New York Times
The Washington Post
Fortune
Newsweek
Slate
Wired (I am quoted here)
Wired again (I am quoted here too)
CNN
(and a 2nd, more humorous, article from CNN)
The BBC
The
Washington Post again
The
New York Times again
The
Mercury News
The
San Francisco Chronicle
Federal
Computer Week
Economic
Principles
The Lighthouse
Op
Ed in The Lighthouse
Several bloggers
have also joined the chorus
Here is a great compiliation of information by Robin Hanson, one of the primary scientists behind the market proposal
(If you're only going to read one thing, stop now and read the
first NYTimes
article above, by Hal
Varian.)
My two cents
First note that futures based on terrorist activities were to play a
very small role in the market, or perhaps none at all. The main thrust
of the market was to predict various quantities relating the the
economic health and stability of countries in the middle east.
Yes, there are legitimate concerns about a completely uncontrolled
terror futures market. But with strict investment limits, careful
record keeping, proper audit trails, carefully crafted financial
instruments, and possibly even restricted access to security-cleared
personnel, there would have been little risk, and great potential
benefits. Yes, it may have failed. This was a research project -- an
experiment -- and research sometimes fails. But it may also have
succeeded in delivering superior information and superior forecasts
about extremely important world events, something most can admit
appear lacking using current methodologies.
The Policy Analysis Market (PAM), dubbed "Terror Futures" by
congressional leaders and the media, was based on decades of research
in economics and finance that markets provide accurate predictions:
more accurate than most other forecasting tools we have. Markets offer
a way to tap into the collective wisdom of a population. Markets don't
care who is the loudest, who is the most aggressive, who is the most
powerful, or who is the most persuasive; markets only care about
accuracy. Those who have better information and can better predict the
future win. Those with poor information or poor abilities to process
information lose. In this way, the good information filters to the
top, yielding forecasts that reflect about as good a vision of the
future as can be found by any other means. This kind of cold
indifference to personalities is often exactly what is needed to
uncover the truth. The ability of markets to provide unbiased
forecasts is not just speculation: it is borne out by countless
scientific investigations of real markets, including options markets,
futures markets, sports betting markets, and even market games where no real
money changes hands.
PAM also could have provided a means for people and organizations to
insure or hedge against major world events. Oil companies, for
example, are very much exposed to the risk of instability in the
middle east. A market like PAM would give them the opportunity to
hedge those risks.
A major objection to PAM was that terrorists or their sympathizers
could manipulate the market to divert attention from their true
targets. This is possible, but the evidence from existing markets is
that manipulation is very hard, because markets punish
misinformation. Those attempting to artificially inflate some
investment stand to lose significant sums of money, and may not even
effect the market price if one or two smart other traders realize what
is going on. In fact, there is evidence from the Iowa Electronic Market, a
futures market in political elections, that a coordinated attempt to
bid up the price of Pat Buchanan shares failed miserably, barely
effecting prices, and causing all the recruited Buchanan supporters to
lose their collective shirts.
A much more serious objection to PAM was that terrorists themselves
might benefit by enacting the very thing they bet on, thus funding
their next terrorist act. This threat was overblown, since the market
would have limited investment to $100 or so. Terrorists looking for
ways to profit on their actions would do much better to short sell
airline stocks or oil stocks, or otherwise exploit existing markets
that have effectively no limits on the amount that can be
invested. There are plenty of ways to manipulate markets and commit
fraud, including, say, perpetrating arson to collect on insurance. But
because there are legitimate reasons for stocks and for insurance, we
don't abolish them just because of the potential for fraud. We instead
monitor for fraud and punish it severely when discovered. It is an
unfortunate truth that we sometime resort to paying large sums of
money to unsavory characters in order to capture other unsavory
characters. It's true that PAM might have benefited some undesirable
elements, and perhaps this is enough to shut it down in its original
form. But their benefit would have been limited, and our benefit could
have been great. Note that, contrary to reports, the government would
not have directly paid anyone: any one trader's winnings would have
come directly from some other trader's losses.
Then there is the moral issue: isn't it simply wrong to place bets on
death and destruction? Well, if so, nearly everyone in the civilized
world is guilty: we all bet on misfortune every day. When you purchase
life, health, or property insurance, you are essentially betting that
something bad will happen. Your insurance company is taking the
other side of the bet. If nothing happens, the insurance company keeps
your payment. If something terrible does happen -- you wreck your car,
or require major surgery, for example -- you "win" the bet and the
insurance company pays you your due. Of course you don't actually wish
for tragedy to strike, but if it does, you want the peace of mind to
know that you will receive monetary compensation. In fact, large
building owners are now taking out terrorism insurance: in doing so,
they are in effect betting on terror, albeit in a way that almost no
one would object to.
I can understand the shock and outrage people felt when they first
heard about PAM. Had I not known anything about the project, I likely
would have reacted the same way. But knowing something of the other
side, and seeing the incredible firestorm burn out of control so fast,
with nearly all coverage and commentary coming in exceedingly one
sided, was both frustrating and frightening to behold. It certainly
makes me think twice about all those seemingly outrageous scandals I
hear about that I otherwise know little about.
It's a shame that PAM -- and all the research programs surrounding it,
most having nothing to do with terrorism -- were dismissed out of hand
in a single day with little discussion and little investigation into
their merits. The bottom line is that PAM, in some form, might have
worked. I certainly hope that other academic and commercial projects
investigating the predictive power of markets will proceed.
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Related Links
These lists are by no means exhaustive -- consider this section
"under construction"
- Real markets: Real forecasts
The proof of the forecasting power of markets is in the
pudding. Beyond our standard financial derivatives markets (e.g.,
options and futures markets), here are some interesting
real-money markets with a proven track record of
predicting the outcome of a huge number of events spanning a wide
variety of topics.
- The Iowa Electronic Market
(IEM). A not-for-profit market operated by the University of Iowa
Tippie College of Business. Known for its political election markets,
IEM also offers a markets on a few other topics, for example the
Federal Reserve's monetary policy.
- TradeSports. Offers
markets on a wide range of topics, including sports, politics, and
news.
- Cantor Index. Cantor
Index is a UK-based subsidiary of Cantor Fitzgerald. Cantor Index now
owns the Hollywood Stock Exchange
(HSX), and runs a real-money version of HSX's play-money market
game. Many other so-called spread betting markets are run in
the UK and elsewhere, allowing traders to bet real money on where
various market indices are headed, or how sporting events will
unfold.
- The World Sports
Exchange. Mainly limited to sporting events, but also offers
markets in elections (e.g., the 2004 Democratic Nominee), the Oscars,
American Idol, etc. The site is also a sportsbook. To get to the
markets, from the above link click on "Interactives" or "Futures
Markets" on the left navigation panel.
- The novelty of the sports markets on TradeSports, World Sports
Exchanges, Cantor Index, other spread-betting sites, and other
so-called "in-game" or "in-running" or "peer-to-peer" (P2P) sports
betting sites, is that trades/bets can continue even after the game
starts, right up until the final moment. So as information bearing on
the outcome of the game is revealed -- points are scored, players are
injured, penalties are called, etc. -- traders can react in real
time. Prices reflect the traders' current collective sentiment on the
likely outcome of the bet at any given moment.
- Play-money market games: These traders aren't kidding around
A variety of play-money market games are cropping up on the
Web. They operate like real markets, but no real money changes hands,
thus side-stepping thorny legal and regulatory issues. Research shows that even
market games can provide decent forecasts, sometimes outperforming
experts or polls. It seems players care dearly about their fictitious
portfolios, and the lure of funny money -- fueling community stature
within the game, or sometimes convertible into very real prizes -- is
enough to drive a form of informational efficiency and forecast
accuracy in these games, if not as strong and well-tested as with
their real-money brethren.
- The Hollywood Stock Exchange
(HSX). Probably the most popular and well-known market
game. Offers markets in movie box office results, actor market value,
Oscars, Emmys, and more.
- NewsFutures. A
well-designed and fast growing market game covering anything that is
newsworthy, including politics, current events, entertainment, and
sports. There are also French
and Hungarian versions of
the site.
- The Foresight Exchange
(FX). The granddaddy of market games. With an old-school
interface, this site, inspired by Robin Hanson's Idea Futures concept,
is focused mainly (though certainly not exclusively) on events of
scientific and technological import. FX is the only site with a
mechanism for users to craft and contribute their own market
contracts.
- (A few) People, Organizations, and Companies
- Joyce Berg, Thomas Gruca George Neumann, Robert Forsythe, Forrest
Nelson, and Thomas Rietz -- IEM Board of
Directors, University of Iowa
Tippie College of Business
- Leonard Brody -- Ipreo
- Alexander Costakis -- Hollywood Stock Exchange
- Ely Dahan -- UCLA
- John Delaney -- TradeSports
- Lewis Findlay -- Cantor Index
- Leslie
Fine -- HP Labs
- Michael Foster -- DARPA
- Carol Gebert -- Incentive Markets
- Robin Hanson, Vernon Smith -- George Mason University
- Ken Kittlitz -- Foresight Exchange
- Anthony
Kwasnica, Lee Giles, Tracy
Mullen -- Penn State
- John Ledyard, John Lin, Charles Plott -- Caltech
- Jim Neiers -- Neoteric Technologies
- Charles Polk -- NetExchange
- Carsten Schmidt -- Max Planck Institute for Research into Economic Systems
- Emile Servan-Schreiber -- NewsFutures
- Leighton Vaughan Williams -- The Nottingham Trent University
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