Economists Speak Out on Prediction Markets

We’ve blogged quite a bit about prediction markets. Now, some very prominent economists (including four Nobel prize winners) have come together to release a joint statement asking the U.S. government to make it easier for researchers to create them.

While the statement argues the merits of prediction markets extremely cogently, and while I’m completely in favor of prediction markets and absolutely against governmental prohibitions on them, I elected not to sign the letter for two reasons:

First, and most importantly, I never sign any letter of this kind. These sorts of letters get circulated all the time, often by friends and colleagues. If you sign one them, it becomes harder to say no to the ones that you don’t really believe in. So, my rule is: Don’t sign anything. Having your name attached to something you don’t believe in is far worse than not having your name attached something you do believe in. Plus, I have other ways than letters (like this blog or a New York Times column) to communicate my opinions.

Second, I didn’t think the letter went far enough. It attempts to draw a sharp distinction between prediction markets created by academics for research and other kinds of markets. A subtle implication of that distinction is that the government has some legitimate role in restricting access to prediction/gambling markets more generally. To me, there is no difference between a “prediction” market and a “gambling” market. If there is demand for people who either want financial risk surrounding an event or want to hedge risk, why should the government get in the way? It doesn’t matter whether it’s the value of a bond, a share of stock, a presidential election, a firm’s likelihood of hitting its quarterly numbers, or the chances that the White Sox will win the pennant. In general I am not much of a libertarian, but our government’s policy towards gambling is completely idiotic and rife with internal contradictions. (Case in point: A state run lottery that pays out fifty cents on the dollar is okay, but U.S. casinos are prohibited from being involved in internet gambling sites).


jed.christiansen

Thank you for being a voice of common sense regarding prediction markets.

I want to emphasize your second point; that the letter did not go far enough. After living in the UK for a number of years now, it is odd to see the puritanical view towards gambling that the American government so often takes. If an individual is willing to risk their money on a future event (whether the price of oil or the Cubs winning the pennant) why should the government stop them?

Prediction markets have the potential to be a very disruptive tool in many industries. I run a consulting company specialising in prediction markets; working in Europe (without the US-style regulations) allows my clients here to be much more innovative than they could be in the United States.

egretman

As Bill would say, I feel your pain here, Mr. Levitt. I was with you 100% until the last two lines.

our government's policy towards gambling is completely idiotic and rife with internal contradictions. (Case in point: A state run lottery that pays out fifty cents on the dollar is okay, but U.S. casinos are prohibited from being involved in internet gambling sites).

It's only idiotic if you think guvment doesn't need to protect it's income sources. Just look where gambling has been approved outside of Nevada, almost always in depressed areas needing revenue. The need for revenue and jobs has often trumped religious objections to gambling even in bible-thumping states such as Mississippi.

We need taxes, Mr. Levitt, for all those Cadillac-driving welfare queens hopped up on drugs with 6 kids Or all those 500 lb bombs that we are dropping on Iraq.

I actually think your linking of gambling and prediction markets is a big mistake, if your goal is to see more prediction markets.

Read more...

alecjarvis

I don't follow #2's point. We need tax revenue; why don't we allow US casinos to run online casinos, then, when we can collect tax revenue from their operations? A ban only sends online gamblers to Australian or Caribbean sites.

pparkman

Unlike egretman, I agree completely with Dr. Levitt. Prediction markets, stock markets, horse racing, craps, lottery, investing in real estate; it's all gambling if you define gambling as placing money at risk based on the outcome of chance events. And what other definition of gambling do you have?

I'm not familiar with the laws against prediction markets, but I assume that they are just the laws against gambling, and that the letter-circulators are asking that an exemption be carved out of the gambling statutes for "prediction markets". Sounds iffy to me; legalize gambling, don't draw finer distinctions.

frankenduf

I agree with egretman that linking gambling and prediction markets is unwise in the context of social utility- while the latter is coming of age, hopefully to flourish and minimize social externalities; the former can be quite socially destructive- both to the poor and to the local environs (for casinos)- a reasonable argument could be made that the government would be idiotic NOT to prosecute private exploitation of gambling markets (by gangsters or corporations)

Chris Masse

Prawf Steve Levitt,

Congrats for this great blog post. I agree 100% with you. I'm the publisher of a group blog on prediction markets (Midas Oracle).

In the UK, prediction markets are regulated by the gambling laws (BetFair.com) and at other times by the futures regulations (Spreadfair.com). As a result, BetFair has become the #1 prediction exchange (betting exchange) and is 30 or 35 times bigger than TradeSports-InTrade (which aims at the US market).

It's a pity that there are so many great scholars studying and innovating on prediction markets in the US, and that US-based operators are not free to employ real money for their prediction exchanges. US regulations are killing this nascent industry.

You will tell me that the CFTC welcome financial innovations and that HedgeStreet has been able to expand its range of offerings (it will compete with Economic Derivatives, soon). But what really click the American event derivative traders are sports and politics, not just the financials.

TradeSports-InTrade and BetFair should be free to operate in the US, and as a payback, they should expand their range of socially valuable prediction markets, which will help society to assess important risks.

Read more...

egretman

We ain't London. Right now there are political appointees to the Depts. Of Commerce, Justice, Education, Energy, Health, and State that believe the earth is 6000 years old. And that the world is ending in 5 to 10 years.

I thought it was smart when economists named their gambling as prediction markets to keep it out of the negative connotations. But now here's Levitt trying to relink them.

I say....Icksnay on the Amblingay

htb

jed.christiansen writes:
> If an individual is willing to risk their money on a future event
> (whether the price of oil or the Cubs winning the pennant)
> why should the government stop them?

Because one of those individuals is going to be my semi-disabled, permanently flat-broke dad, and *you*, as a taxpayer, are going to be stuck paying the bills.

We are talking about a guy who actually mailed his rent check to the nice official in Nigeria who was going to make him a millionaire for his assistance with a few simple transactions. Three times!!! He had to lose his money THREE TIMES before he was willing to even *consider* the idea that no one in Nigeria was actually going to make him a millionaire!

The fact that he's technically "willing" to risk losing everything on what he perceives to be a "sure bet" doesn't change the fact that after he lost, he'd be flat broke, homeless, unemployable, and eligible for almost every welfare program in the books.

He's already gone bankrupt (possibly twice), and been evicted (twice in the last couple of years that I know of), and there may be criminal prosecutions in his future for some of his get-rich-quick schemes. It seems that any time someone came around with a new pyramid scheme, a new "business model," a new anything, he apparently bought into it.

He'd be a complete sucker for your "prediction markets," which he would perceive as an unshakably "legitimate investment." One short news story about someone making a million dollars, and he'd send his grocery money to "invest" in your "market."

(No, he's not a compulsive gambler, and he doesn't have any signs of mental illness except perhaps a moderate case of narcissism. He just believes that God sincerely wants him to live in luxury without having to earn it, and four decades of steady and painful failure have not deterred him from the possibility of getting rich quick with the next scheme.)

My point is this: The question is not merely, Shall we have semi-legitimated gambling, the way we have, say, regulated commodities futures. The question in my mind is, Do you-the-taxpayer really want to create another mechanism for parting fools from their money, so my dad can end up on welfare -- again, although possibly with a court-appointed financial conservator the next round, so his rent gets paid before his "revenue generating websites" [the latest in a long string of get-rich-quick schemes] do -- at *your* expense?

I expect that the financial side of this issue could be decided through a rational economic analysis; either the additional friction in the markets (from, say, people going bankrupt) and additional costs (such as welfare) will exceed the benefits (tax revenue to pay for those extra welfare and court cases)... or it won't.

But I think we need to be more aware of the costs than most proponents seem to be.

Read more...

robinhanson

Signing a statement in favor of legalizing A, when both A and B are now illegal, does not mean that one favors keeping B illegal. Not every statement can or should address every issue.

adrian

Im so angry about these people caring only about themselves. I myself nearly 18 this coming october, look for a good start in life all i can say thats not gonna happen. My familys currently so poor its 20$ for us every day minimum to get dinner, and i always end up getting lunch money 5$ a day. But today i get no lunch money so i sit eating very little pancakes that are so old with little syrup hoping it will last me through out the day till i can get somehelp from a friend or my loving girlfriend to feed me.

waltinseattle

I generally like the idea of predictive "markets. But they should be completely separated from the actual markets. Its one thing to play with chips, it's another thing to play with other peoples' money and to be big enough to wag the currency.

The current moral hazzard casino allows "comps" for speculators bankrolled by other people and by the faith behind currencies. Sometimes the chips are called and the wrong, nonplaying people, get to ante up the shortfalls. Another comp is "bonuses" oh my, don't get me started about the mathematical scams behind those arguments!!

jed.christiansen

Thank you for being a voice of common sense regarding prediction markets.

I want to emphasize your second point; that the letter did not go far enough. After living in the UK for a number of years now, it is odd to see the puritanical view towards gambling that the American government so often takes. If an individual is willing to risk their money on a future event (whether the price of oil or the Cubs winning the pennant) why should the government stop them?

Prediction markets have the potential to be a very disruptive tool in many industries. I run a consulting company specialising in prediction markets; working in Europe (without the US-style regulations) allows my clients here to be much more innovative than they could be in the United States.

egretman

As Bill would say, I feel your pain here, Mr. Levitt. I was with you 100% until the last two lines.

our government's policy towards gambling is completely idiotic and rife with internal contradictions. (Case in point: A state run lottery that pays out fifty cents on the dollar is okay, but U.S. casinos are prohibited from being involved in internet gambling sites).

It's only idiotic if you think guvment doesn't need to protect it's income sources. Just look where gambling has been approved outside of Nevada, almost always in depressed areas needing revenue. The need for revenue and jobs has often trumped religious objections to gambling even in bible-thumping states such as Mississippi.

We need taxes, Mr. Levitt, for all those Cadillac-driving welfare queens hopped up on drugs with 6 kids Or all those 500 lb bombs that we are dropping on Iraq.

I actually think your linking of gambling and prediction markets is a big mistake, if your goal is to see more prediction markets.

Read more...

alecjarvis

I don't follow #2's point. We need tax revenue; why don't we allow US casinos to run online casinos, then, when we can collect tax revenue from their operations? A ban only sends online gamblers to Australian or Caribbean sites.

pparkman

Unlike egretman, I agree completely with Dr. Levitt. Prediction markets, stock markets, horse racing, craps, lottery, investing in real estate; it's all gambling if you define gambling as placing money at risk based on the outcome of chance events. And what other definition of gambling do you have?

I'm not familiar with the laws against prediction markets, but I assume that they are just the laws against gambling, and that the letter-circulators are asking that an exemption be carved out of the gambling statutes for "prediction markets". Sounds iffy to me; legalize gambling, don't draw finer distinctions.

frankenduf

I agree with egretman that linking gambling and prediction markets is unwise in the context of social utility- while the latter is coming of age, hopefully to flourish and minimize social externalities; the former can be quite socially destructive- both to the poor and to the local environs (for casinos)- a reasonable argument could be made that the government would be idiotic NOT to prosecute private exploitation of gambling markets (by gangsters or corporations)

Chris Masse

Prawf Steve Levitt,

Congrats for this great blog post. I agree 100% with you. I'm the publisher of a group blog on prediction markets (Midas Oracle).

In the UK, prediction markets are regulated by the gambling laws (BetFair.com) and at other times by the futures regulations (Spreadfair.com). As a result, BetFair has become the #1 prediction exchange (betting exchange) and is 30 or 35 times bigger than TradeSports-InTrade (which aims at the US market).

It's a pity that there are so many great scholars studying and innovating on prediction markets in the US, and that US-based operators are not free to employ real money for their prediction exchanges. US regulations are killing this nascent industry.

You will tell me that the CFTC welcome financial innovations and that HedgeStreet has been able to expand its range of offerings (it will compete with Economic Derivatives, soon). But what really click the American event derivative traders are sports and politics, not just the financials.

TradeSports-InTrade and BetFair should be free to operate in the US, and as a payback, they should expand their range of socially valuable prediction markets, which will help society to assess important risks.

Read more...

egretman

We ain't London. Right now there are political appointees to the Depts. Of Commerce, Justice, Education, Energy, Health, and State that believe the earth is 6000 years old. And that the world is ending in 5 to 10 years.

I thought it was smart when economists named their gambling as prediction markets to keep it out of the negative connotations. But now here's Levitt trying to relink them.

I say....Icksnay on the Amblingay

htb

jed.christiansen writes:
> If an individual is willing to risk their money on a future event
> (whether the price of oil or the Cubs winning the pennant)
> why should the government stop them?

Because one of those individuals is going to be my semi-disabled, permanently flat-broke dad, and *you*, as a taxpayer, are going to be stuck paying the bills.

We are talking about a guy who actually mailed his rent check to the nice official in Nigeria who was going to make him a millionaire for his assistance with a few simple transactions. Three times!!! He had to lose his money THREE TIMES before he was willing to even *consider* the idea that no one in Nigeria was actually going to make him a millionaire!

The fact that he's technically "willing" to risk losing everything on what he perceives to be a "sure bet" doesn't change the fact that after he lost, he'd be flat broke, homeless, unemployable, and eligible for almost every welfare program in the books.

He's already gone bankrupt (possibly twice), and been evicted (twice in the last couple of years that I know of), and there may be criminal prosecutions in his future for some of his get-rich-quick schemes. It seems that any time someone came around with a new pyramid scheme, a new "business model," a new anything, he apparently bought into it.

He'd be a complete sucker for your "prediction markets," which he would perceive as an unshakably "legitimate investment." One short news story about someone making a million dollars, and he'd send his grocery money to "invest" in your "market."

(No, he's not a compulsive gambler, and he doesn't have any signs of mental illness except perhaps a moderate case of narcissism. He just believes that God sincerely wants him to live in luxury without having to earn it, and four decades of steady and painful failure have not deterred him from the possibility of getting rich quick with the next scheme.)

My point is this: The question is not merely, Shall we have semi-legitimated gambling, the way we have, say, regulated commodities futures. The question in my mind is, Do you-the-taxpayer really want to create another mechanism for parting fools from their money, so my dad can end up on welfare -- again, although possibly with a court-appointed financial conservator the next round, so his rent gets paid before his "revenue generating websites" [the latest in a long string of get-rich-quick schemes] do -- at *your* expense?

I expect that the financial side of this issue could be decided through a rational economic analysis; either the additional friction in the markets (from, say, people going bankrupt) and additional costs (such as welfare) will exceed the benefits (tax revenue to pay for those extra welfare and court cases)... or it won't.

But I think we need to be more aware of the costs than most proponents seem to be.

Read more...

robinhanson

Signing a statement in favor of legalizing A, when both A and B are now illegal, does not mean that one favors keeping B illegal. Not every statement can or should address every issue.