Friday, May 11, 2007

When Gambling Is Good

I think a distinction between gamblers and traders needs to be made (so I made it here). That said, here is a WSJ op-ed (subscription required) by Hahn & Tetlock:

The crystal balls are called prediction markets or information markets, and they help forecasters, for example by allowing traders to vote with their money on the future unemployment rate or the winner of the next presidential race. If you visit the Iowa Electronic Markets, you can take a financial position on the Democrats' chances of winning the White House in 2008. As this is being written, a contract purchased for $6.15 would yield $10 if a Democrat wins, allowing analysts to infer that the "market" believes the Dems have a 61.5% chance of taking the election.

Some businesses, meanwhile, use internal information markets to predict outcomes of specialized interest. Hewlett Packard asks employees to predict revenues and operating profits, believing the exercise can add useful information to conventional forecasting methods. HP is even pondering the sale of a commercial version of its BRAIN (Behaviorally Robust Aggregation of Information in Networks). Eli Lilly has used these markets to help predict which newly developed chemical entities will become successful drugs. Google has used the approach to forecast product launch dates.

These markets often predict more accurately than experts. Why? They draw on the knowledge of people who might otherwise be ignored. Their anonymity frees participants from pressures to agree with opinion leaders. And they create straightforward profit incentives that encourage participants to search for better information.

Many academics across the political spectrum are excited that prediction markets could improve decision making in a whole host of arenas. Yet regulatory restrictions imposed by federal and state anti-gambling laws make these markets risky to operate. The Iowa market -- deemed by regulators to be a teaching device -- is the only public forum in the United States where the technique can be used with great flexibility, low cost and little fear of government intervention.

But when did politicians actually move the ball forward? They are too busy shaving points for their donors and voters. Points that the silent majority pays for. As usual.

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