The Speculist

Now That the Idea Has Been Killed

Just watch it take off.

It's no coincidence that the WiredNews story that I linked to for ITF #9 should run so soon after the demise of the proposed futures market in terrorism. Only now, after this idea has been brought to public attention via its dismissal, are we taking the opportunity to evaluate it.

As I've said, I think there may be tremendous potential for this kind of market. Consider the case of the Irish Sports Book site where gamblers are even now attempting to make a buck from the ousting (or survival) of California Governor Gray Davis. They currently give Davis only about a 35% chance of surviving.

Those who believe Davis still will be in office at the end of the year stood to win $6 for every $4 wagered. Those betting against Davis -- selling the contract short -- would win $3.10 if he is out of office, or lose $6.90 if he bucks the odds and keeps his job.

Hal Varian, a professor of business at the University of California at Berkeley, said such online markets provide better predictions than traditional polls because cash forces a more dispassionate analysis of issues.

"You talk to a loyal Democrat they'll say, 'Oh no, Gray Davis won't be recalled.' You talked to a Republican they'll say, 'Of course, that bastard will be taken out of office,"' Varian said. "They let their emotions or their desire influence their beliefs and opinion polls are subject to that wishful thinking."

"When it is money and the market is moved by the smart players, the guys who are weighing the odds and not weighing their emotions, you get a better forecast," he continued. "You have to put your money where your mouth is."

This is the case for futures markets in a nutshell.

We need to know where things are going, and these markets seem to be a clear (and fairly accurate) way of getting a handle on that. Plus, here's an interesting twist, from an analysis by James Pethokoukis earlier this week:

But these markets seems to do pretty well even if only fake money is at stake. The Foresight Exchange, around since the mid 1990s, allows traders to make bets on terrorists attacks -- and pretty much anything else -- with pretend money. And in a study of its predictive prowess, Douglas Hubbard, a risk consultant in the IT industry, found that when the Foresight Exchange markets said an event had a 30 percent or 50 percent or 70 percent chances of happening, the outocme pretty much fit those forecasts. Ken Kittlitz, co-founder of the Foresight Exchange, told me that "even though we only use play money, people try to bet rationally because they feel inside that they have their reputations on the line."

This struck me as pretty interesting, so I decided to give it a shot. I now have an account with Foresight Exchange. They start you out with $50. So Far, I have invested in the following predictions.

• That there will be a building taller than the Empire State Building in Manhattan (the payout on this one is driven by when it occurs.)



• That the United States will have fewer than 20,000 active duty military personnel stationed in Germany on December 31, 2013.



• That the US will not be nuked by the year 2010 and that President Bush will be re-elected in 2004.

Looking at these predictions, I have to wonder how the market can possibly impact their accuracy. I mean, here I am participating and I don't have any special knowledge about any of these things. I'm just a follower.

For example, the Empire State Building prediction was selling at 78, meaning that the investors collectively figure there is a 78% chance that the prediction will come true within the assigned time frame. So no way was I going to bet against that.

Likewise, the Troops Stationed in Germany prediction was trading in the high 70's. What do I know about troop deployments? Zip-a-dee-doo-dah. This is where you want your Steven Den Beste or someone of his ilk participating. Actually, in placing the bet, I was going on the idea that there are a couple of SDB's in there driving the price — with the rest of us just sort of along for the ride. Does my participation impact the accuracy of the prediction for the better or the worse? Or have no impact?

I really can't say, but I find it unlikely that it has no impact. Somehow I'm in there pushing it one way or another. And even if most of us who participate aren't experts, the predictions that we make are as good as, or better than, predictions made by any given expert.

Whoah.

Wait a second.

Isn't this some kind of collective intelligence we're talking about here? As a small "l" libertarian, my knee is jerking violently in reaction to any suggestion that a collective something could possibly be better than an individual anything.

Fortunately, there's money involved. That's different. That makes it a market. Even us small "l" libertarians can endorse collective behavior and decision-making if it's defined in those terms.

What a relief. That was a close one.

Finally, that last prediction I bought into is kind of a mutual fund of future events. In order to get paid, I need for Bush to be re-elected in 2004 and for us not to be nuked by 2010. Either of those events can be purchased as a stand-alone prediction. The We Get Nuked prediciton is currently selling at about 26. So there's your futures market in terrorism.

It's kind of scary if you think about it. If the Foresight Exchange really is accurate in predicting outcomes, then we could have somewhere in the neighborhood of a 25% chance of being nuked by 2010. (The selling price is based on the Yes prediction that we will be nuked; the "mutual fund" I bought into pays out on the No prediction.)

Actually, it's scary, but it isn't exactly news. I can't say for sure, but I think that had I been asked (before logging on to the exchange) what I thought the chances are of the US being nuked by 2010 — I might very well have said something along the lines of 25%.

So maybe collective intelligence is just a fancy way of saying common sense? Or even consensus? I'm not sure. What I am sure about is that I'm going to continue looking into futures markets as a way of dealing with rapid change and making the most of my future. I suspect many others will do the same.

Meanwhile, WiredNews has more on the fallout from the Futures Market controversy — it seems that John Poindexter is going to resign in light of his involvement with the futures market and the Terrorism Information Awareness system. I wonder if any markets saw this coming?

They probably did.

In retrospect, it seems like a sucker bet.

UPDATE: Rand Simberg has been putting up some very interesting stuff on this. Look here and here. I think that Caymans idea sounds like a good one. Maybe somebody just needs to talk the Foresight Exchange folks into running their little operation on a different set of servers and changing the currency to real money. Also, check out these two postings to Just One Minute (here and here) which indicate that the existing stock market has probably already been manipulated as a terrorist futures market.

Posted by Phil at August 1, 2003 06:56 AM | TrackBack