Progress on Prediction Markets

One of the real barriers to widespread adoption of prediction markets by U.S. corporations has been a murky legal environment. Are prediction markets legitimate business tools, an alternative set of securities markets requiring SEC regulation, illegal betting markets, allowable games of skill, or something else altogether?

Fortunately, the Commodity Futures Trading Commission is stepping up to the plate, and I’m hopeful that this will eventually lead not only to regulatory certainty, but also provide a useful framework for the operation of prediction markets.

The difficulties in shaping appropriate regulation come from the fact that:

Contracts have been based on a wide variety of interests, including the results of presidential elections, the accomplishments of certain scientific advances, world population levels, the adoption of particular pieces of legislation, the outcomes of corporate product sales, the declaration of war, and the length of celebrity marriages.

Obviously some of these prediction markets are more socially useful than others.

On May 1 the C.F.T.C. announced that it is trying to figure out:

1. Whether prediction markets fall into their jurisdiction.
2. If so, whether there should be exemptions or exclusions applied.
3. How they should address the possible pre-emption of state gaming laws.

At this point, the C.F.T.C. is simply requesting public input. A much longer background document (with enough legalese to make any lawyer happy) is available here.

More from David Pennock, here. And Vern Smith is the first to register a formal comment, here.

[Hat tip: Bo Cowgill.]

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  1. Ian Lamont says:

    I find it interesting that online media companies have been using public prediction markets for years. The MIT Technology Review was one of the first ones earlier in the decade, and the Hollywood Stock Exchange is a more well-known example.

    The Industry Standard has a very active prediction market centered around technologies, companies (including publicly listed firms) and products. As managing editor of the publication, I can say that it has been very interesting to monitor the accuracy of this tool over time, based on the expertise and insights of our readers. And make no mistake: This is a tool.

    Ian Lamont
    Managing Editor
    The Industry Standard

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  2. Kyle S says:

    The main difference between prediction markets and public capital markets (like the NASDAQ, e.g.) is that capital markets are positive sum, whereas prediction markets are negative sum (due to trading costs). Still, the same thing can be said about option exchanges, right? Prediction markets seem most analogous to weather futures markets, which certainly hotbeds of speculation allow plenty of legitimate use (like hedging for companies in weather-sensitive industries). Wouldn’t it make sense for a defense contractor to buy a bunch of Obama-08 futures as a hedge right about now?

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  3. Wesley says:

    Don’t polls influence results in elections? If prediction markets for elections became mainstream, campaigns could start bidding up their candidate as a way to indirectly influence election results.

    Wesley Tanaka

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  4. Omer Ehtisham says:

    Prediction markets are commonly found in asian options.
    A look back feature to validate a prediction and re-price as a result is, in my humble view, another valid example of a prediction market in action. Accounting is done at fair value on the balance sheet.

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