Those that aren’t prediction / event / outcome market affectionados, might not have realized that the CFTC recently asked
…for public comment on the appropriate regulatory treatment of financial agreements offered by markets commonly referred to as event, prediction, or information markets.
During the past several years, the CFTC has received numerous requests for guidance involving the trading of event contracts. These contracts typically involve financial agreements that are linked to events or measurable outcomes and often serve as information collection vehicles. The contracts are based on a broad spectrum of events, such as the results of presidential elections, world population levels, or economic measures.
As you might have expected my immediate reaction was - it’s about bloody time! (Or more cynically, that the CME had finally figured out / got around to working out how to monopolize compete in these emerging markets.) The deadline for comment was July 7th and although I haven’t had the time to look closely at many responses (available here from the CFTC), I was heartened to read John Delaney’s (InTrade CEO) contribution thanks to Chris’ posting of it at Midas Oracle (incontournable for keeping up with all the latest news and gossip on the subject of prediction markets.) It’s too bad the CFTC’s website doesn’t have a Digg/Shashdot-type mechanism* for people to vote up (or down) contributions. If it did I would certainly have endorsed this contribution - well crafted, robust, articulate and (imo) stating the blindingly obvious (which btw is a good thing in this Kafka-esque context.) My thoughts as to the contradictions implicit in the increasingly anachronistic US regulatory system are on record, and I hope this first baby step by the CFTC is a prelude to more great modernization to come. Jed - another good source of event market news and analysis - thinks it will happen only very slowly if at all. I wonder if we can get Obama’s staffers to put this in the ‘Yes We Can’ column!
*seriously this could be a great idea for any government agency soliciting public input. Many people simply do not have the time/money to craft a complete and articulate response but are very likely to find one or more responses submitted by others that they are happy to endorse. Clearly you would have to guard against gaming/spamming but I’m sure clever people could mitigate / manage around this. I read that Obama is keen to introduce modern web-based tools to government if he is elected. Maybe someone on his staff will pick this idea up and run with it.
Well it seems that these same good folks have lost a bit of their nerve as 2008 hurricane season starts and the metaphorical roulette wheel starts to slow (from the Guardian):
Warren Buffett’s Berkshire Hathaway fund has taken a $224m (£113m) bet that Florida will not be hit by devastating hurricanes in the coming months. That is the amount the US state has agreed to pay Berkshire upfront in return for the fund coming to its rescue if hurricane damages cost more than $25bn this season, which runs from June 1 to November 1.
If damages exceed $25bn, Berkshire will buy $4bn in 30-year bonds issued by the state. The money will ensure Florida does not run into cash flow problems in the clean-up. Florida will have to buy the bonds back; the interest rate is 6.5%. State officials have agreed to the deal, even though they admit there is only about a 3% chance of damages going so high, because they believe the credit crunch could limit their access to funds if this is a particularly bad hurricane season.
So let me get this straight. Basically Florida lined up a loanshark, just in case they couldn’t pay their bookie if their bet didn’t come in. It looks like a pretty clever deal for Vinnie Mr. Buffett: if the terms have been correctly reported, effectively he is being paid $224mn for a ‘knock-in’ credit spread + interest rate lock. On $4bn of bonds, if the knock-in is exercised, the premium should protect Buffett up to c. 7% before he starts incurring mark-to-market losses on the overall trade. I’m no expert and it’s late so I’m not even going to try to hack a model together, but it seems like this is a pretty good deal for the man from Omaha. (And btw, a derivative by any stretch of the imagination…)
It’s also probably a relatively prudent thing for Florida to do, even though they obviously shouldn’t be in such a dire position to start with…and does beg the question, is this the best deal they could do? I can’t get the image out of my head of some hapless middle aged gambler, knuckles white as his nails dig deep into the felt, all the blood drained from his face, beads of sweat gathering on his pencil moustache, as the terror washes over him with the realization that the dice moving in slow motion down the table…might just come up snake eyes…
For those of you who aren’t prediction market enthusiasts, there is a vibrant community that has developed - much of it manifested online - over the past few years. Like many such emergent communities, there is much passion amongst the members for there chosen area of focus. Generally this is a good thing but is not immune to excess from time to time as some of this passion occasionally splills over into what might fairly be described as zealotry. I guess I would consider myself to be a member of this community, probably somewhere towards the middle or the back of the room: trying to follow the main plots, absorbing quite a bit of information and occasionally asking a question or making an observation. So in this micro-context, on the spectrum from zealot to reactionary sceptic, I’d probably be halfway between the middle and sceptic; however if you choose the general population as your sample, I’d be close to the zealot camp. Everything is relative.
But - much as I entertain a similar passion for the potential power of markets in “predictions” as many of the leaders of this movement, I have to chuckle when I run across some of the more - shall we say “emotional” discussions within this community. Again while this is a common characteristic of most new ‘movements’, and in no way unique to passionate prediction market proponents, it is still funny to see this community’s People’s Judean Front and the Judean People’s Front equivalents bash it out on the airwaves so to speak.
And of course there is a small fringe that is keen to control the terms of engagement - the quintessential ‘rule-writers’, often obsessing about semantics and making sure that everybody innovates but only in the ‘right’ way. Another irony - from my point of view - is that many (perhaps most?) of the most active, eloquent and committed members are American (or more relevantly based in America), where of course the wise people in Washington, DC make it as hard as possible to run said prediction markets without risking 2-5 years… Actually, when you stop to think about it this is actually less surprising than at first glance: repression is a great catalyst to passion. (Thank goodness!)
Anyhow, last week’s Clinton victory in the New Hampshire primary has thrown this community into a tizzy…sort of like kicking an anthill…many many column inches have been written defending, deriding and analyzing the fact that the ‘(prediction) market(s)’ got it WRONG! ie Didn’t accurately predict the outcome - indeed they were no better than the POLLS! Oh the shame…
Well - and I suspect many others have already made the same observation so I make no claims to any original insight - this line of reasoning misses the point entirely in my opinion. The ‘failure’ of New Hampshire was the result of primarily two factors:
It wasn’t a failure. No market is always right. More importantly markets reflect the information available to and the interests of their participants. Basically markets are very efficient mechanisms (I would claim the most efficient) for processing information. No more, no less.
In this particular instance, the probability of the market producing an erroneous forecast was high due to the lack of liquidity. This is a problem of all political markets in the US. Show me a market on the New Hampshire primaries with tens of thousands of participants and millions of dollars traded and I will show you a market that creates more valuable information. BUT it would still on occasion be ’surprised.’
Basically I guess what I’m trying to say is the expectations seem to be set all wrong by many inside the community. I think “prediction markets” - creating markets in information and outcomes is a wonderfully important and valuable thing to do. Equally however I think that anyone that represents such markets as being able to predict the future is a charlatan. What they can do is collect and synthesize powerfully and efficiently all the dispersed available information - using money as the relevance filter. This is very valuable in its own right and is defensible. Promoting prediction markets to true sceptics (ie mainstream American politicians) on the basis that they are a Delphic Oracle is surely a path to certain tears and ultimately is almost guaranteed to fail.
Markets don’t compute unknown unknowns. That doesn’t mean they are useless, just that they have to be understood in context.
I’m about as far away from being knowledgeable about horse racing (and betting on horse racing) as you can get, so I might have this all wrong, but it would seem to me that their are remarkable similarities between the “starting price” (for a horse race) and a “fixing (price)” on an exchange. (Previous thoughts on gambling v. trading here.)
Historically, starting prices (for UK horse racing) were set by the big bookmakers and as was pointed out in the June 2004 BBC programme “Battle of the Bookies”, these were routinely subject to manipulation by the big high street betting shops; with a relatively small stake (in comparison to the total amounts staked in their shops) they could move the on-course prices used to determine the starting price, generally shortening the odds of the favorite(s). The programme pointed out that with the advent of Betfair, this was getting harder and harder to do as arbitrageurs popped up to trade the price discrepancy between what was available “on-course” at the prices trading on the exchange.
Indeed if you look at fixings on financial markets, these are highly regulated by the exchanges and regulatory authorities to eliminate and prohibit this kind of artificial price setting. (See for example the rules of the London Stock Exchange.)
Indeed, the starting price is nothing more than the strike against which the bookmaker sells his outcome options on the race. The closer the starting price is to the “true price” (all outcomes add up to a 100% probability), the lower the margin for the options writers. As is the case in financial markets as well, the “OTC” (over-the-counter) providers of derivatives are often loathe to see prices migrate to a (commoditized) exchange environment as the usual result is significant margin compression as prices become transparent. The parallels aren’t perfect but in this context it doesn’t surprise me that the traditional “dealers” (read: bookies) aren’t very happy with Betfair’s plans to publish its own starting price:
In early November 2007 it was reported that Betfair was set to make a big announcement regarding the publication of its own SPs. On 13 November 2007 The Guardian reported;
“Betfair has spent two years developing a robust system to allow bets to be placed at its own SP. As a result, three extra columns will soon be added to its display for every win market on its British and Irish racing service: one for bets on a horse at the Betfair SP, one for “lay” bets against it at SP, and a “guide” price in the middle showing what the SP is likely to be…..SP bets will have some differences from “normal” bets on Betfair. Whereas normal bets can be cancelled until the moment when a rival gambler accepts the other side of the bet, SP bets cannot be cancelled once placed. Punters can, however, specify a minimum price at which they are willing to back, and a maximum price for lay bets.”
In the table below we look at the November Handicap run at Doncaster on November 10 2007, and compare the official SP with the “Betfair SP”. The horses are listed in market order and not order of finish.
The first thing to note is that the SP over-round on Betfair, including commission, totalled 108.5 against an official SP over-round of 127.9.
Of course if your business model (as a bookie) requires a 20%+ gross margin, things could get a bit tough…The question then becomes one of (a) can I continue to innovate and go “up-market” (more complex products - ie exotic derivatives) to preserve margins and/or (b) can I make my (”flow”) operations more efficient so that I can profit from much thinner margins (but probably) higher volumes? I suspect the answer to both questions is potentially yes but requires a fundamental reappraisal of one’s business model: a new paradigm. Unfortunately something that successful incumbents (and their managers) in every industry often find extremely challenging if not impossible to do.
(It also raises the question as to whether the distinction made between businesses subject to regulation by the Gambling Commission and the FSA is more a question of semantics than anything else. Merger anyone?)
Jed Christiansen at Mercury Research & Consulting has just posted an excellent and comprehensive listing of the many and varied prediction market companies and software solutions available today - a great resource and jumping off point for anyone wanting to research this emerging phenomenon. Although I think I understand why, I was surprised not to see Betfair listed: clearly for anyone in the UK interested in this space they will have already heard of it and it is perhaps not exactly a “prediction market” at least not in the same genre as many of the companies listed, nonetheless in other ways it is the shining success among outcome exchanges and especially in the US (due to Betfair’s strict adherence to US law) is not necessarily known or understood by everyone.
In any event, well done Jed for making this mini-survey available to all.
In the room, it turns out, toil 40 people with 40 unusual jobs. They’re the “fraud team” and the “integrity team” of the Internet gambling colossus Betfair, which handles more daily trades than the New York Stock Exchange. Barton-Nicol heads the Risk Investigations department, and the specialists who undergo three months of training and spend eight-hour shifts scrutinizing wagering patterns had detected something with Davydenko-Arguello that qualified as, to use a popular British word, dodgy.
Would be interesting to compare Betfair’s approach and resources with those of the SEC or FSA in terms of insider trading enforcement.
The irony is that true games of chance like slot machines (and lotteries) that exploit our behavioral wiring are legitimized in the US while most forms of outcome trading (or betting, on sports, events, etc.) is criminalized despite the fact that success in outcome trading is not impossible and indeed is predicated on informed analysis.
And to think, you used to be able to smoke while playing the slots…
For those of you who have not been following the French election (here is a good synopsis of the first round from Tim King at Prospect), this weekend France will choose between two very different visions of the future. On Wednesday, I watched the televised debate between Sarkozy and Royal. And having led the field throughout, if you believe the betting market, he will be the next President, with over €1mn traded he is currently priced at 1.12 on Betfair (1:8 on, or c. 88% probability):
Given the well known predictive powers of such markets, I have been somewhat dismayed not to see this referred to once during the campaign; obviously I haven’t read or watched every bit of mainstream press coverage of the election but I have been following the campaign closely and have never seen a mention of the Betfair market (or InTrade which although less liquid has a similar price, efficient markets oblige!) not even in the Economist, relying as with the rest of the press on polls alone (these too have Sarkozy ahead with c. 53% of the expected vote.)
Many sense that this election may mark a turning point for France. Volume is high (as they say in the trade) - giving real significance to the result on Sunday (from The Economist):
This weekend’s presidential election has captured the imagination of the French like nothing else for years. On Wednesday May 2nd, a huge 20m-plus people tuned in to a two-and-a-half-hour television debate between the Socialists’ Ségolène Royal and the Gaullists’ Nicolas Sarkozy—nearly as many as watched the 2006 World Cup final. Campaign rallies have drawn tens of thousands. Turnout in the first round of voting was at its highest since 1974. The burden of expectation about the start of a new era, after 12 stagnant years of Jacques Chirac, is almost worryingly high.
If Sarkozy wins, my view is that it will be due to a strong vote from the (usually) silent majority who (as witnessed in the enormous turn-out) have had enough. France is clearly not the only democracy that suffers from capture by motivated and vocal advocates of what ultimately are views held only by a minority, but for many many reasons (enough to fill several books I’m sure) France has had a particular bad time of it in this respect over the past 20 years. But every once in a while, when enough-is-enough, the silent majority makes itself heard. And for its rarity, the sound is reverberates that much louder.
The French are just as capable, intelligent, innovative, industrious as any other nation, possibly more than most, making the politics of defeatism, fear and envy that have monopolized the economic and political scene in France since (at least) 1981 even more frustrating and depressing than they would naturally be. The apogee of this incredibly pessimistic world-view, utterly lacking in self-esteem is embodied by the thinking behind ‘les 35 heures’ - the government legislated work week; a policy that is rooted in the fallacy that there is a fixed amount of work that needs to be ’shared’ and yet another example of the State micro-managing the economy. Indeed the conviction that the State can and should seek to ‘fix’ all the problems of the nation and its citizens is a belief that has historically had significant currency in France. It will be interesting to see if - by voting for Sarkozy - the French have had enough of being treated like children by an over-ambitious State. Indeed one of the great (unintended) tragedies of French government policies - especially policies with respect to taxes (including social security ‘contributions’) and suffocating labour regulation - has been to expatriate hundreds of thousands of some of the brightest, most ambitious of their citizens. One only has to look at London which with several hundred thousand French nationals is probably the wealthiest and most dynamic ‘French’ city. How many great French entrepreneurs have had to leave the country in order to successfully get their business off the ground? Of course these are the very people who are the key catalysts of job creation, only the jobs are not being created in France. What if France took the approach Ireland took a decade ago and created a environment friendly to business and to success? My personal opinion is that you would see a flood of expatriates returning home, creating hundreds of thousands of jobs and significant wealth.
Both candidates have made much noise about how they want to help entrepreneurs and small business owners. Royal wants to give special tax breaks and institute a number of State run programs to encourage small businesses. But what is really needed is for the State to get out of the way. Less not more. Sarkozy is at least acknowledging that there is a need to stop suffocating business and entrepreneurs, although he - perhaps through conviction, perhaps through electoral pragmatism - also advocates a strong role for the State in the workings of industry. It’s is unfortunate that he chooses to highlight the rescue of Alstom not as a sound and (very profitable) ‘trade’ - which it was - but as a chauvinistic protection of French industry. Rather than rail at the evils of hedge funds, he should be striving to bring the same dispassionate performance-driven approach to managing the assets of the State and helping the French to understand that the best - the only - defence against ‘insecurity’: unemployment, low wages, poor prospects, is a flourishing, dynamic and wealth-creating economy. It is also the only true guarantor of the sustainability of generous and high quality public services over time.
Perhaps, just perhaps, the French people are ready to stand up and take their individual destinies back into their own hands. As Mr. Sarkozy is wont to say:
Il n’y a pas de fatalite.
If indeed he is elected though, I hope he will be able to temper his own prediliction for seeing the State as a means to every end and perhaps take another look at the thinking of Bastiat: a great French classical liberal theorist, political economist, and member of the French assembly (quoted at the beginning of this post) who managed to combine sound economic thinking with eloquence and wit. I always wonder why his arguments never seem to be used in the French political arena to defend liberty and markets; I mean after all he’s not some dodgy foreigner like Adam Smith or Milton Friedman! In an article published in July 2001, The Economist does a good job of summarizing Bastiat’s contribution to the economic canon:
Bastiat is best known for an essay in which he petitions parliament on behalf of the candle makers of France. His complaint is against the “ruinous competition of a foreign rival who works under conditions so far superior to our own for production of light that he is flooding the domestic market with it at an incredibly low price.” The rival is the sun. His proposed remedy is the mandatory shuttering of all windows. That, he claims, using all the standard protectionist arguments, will benefit not only the candle industry but also all the industries that supply it. As a compelling statement of the case for free trade, this essay is hard to beat.
During the building of a railway to Paris, it was proposed that there should be a break in the line at Bordeaux because it would help businesses there, such as porters, storage firms and hoteliers. Brilliant, said Bastiat. What better way to boost prosperity in France than to have similar breaks at Angoulême, Poitiers and all intermediate points? “By this means, we shall end by having a railroad composed of a whole series of breaks in the tracks, ie, a negative railroad.”
Noting the popular view that exports are good and imports bad, Bastiat wondered if the best outcome would be for ships carrying goods between countries to sink, thus creating exports without imports. Debunking the “lump of labour fallacy” before it was even given that label, he suggested that to parcel out the limited amount of work available, people should be required to use only one hand, or even to have a hand chopped off. Missing the irony, France recently imposed a maximum working week of 35 hours a person, hoping to share out available work.
France is a remarkable nation, and as my adopted country I have been enormously frustrated by the policies and mindsets that have tied it up in knots. Indeed its success despite these shackles only serves to underline the tremendous potential that could be unleashed. So Sunday I hope that whatever the outcome, this election will have marked the moment when the French decided that the politics of envy and dependence were not worthy of them and they deserved the opportunity to fulfil their vast potential.
And of course anyone wanting to hedge against the possibility of a Royal presidency can get a pretty cheap option at c. 10 to 1 at Betfair, and given the unpredictability of the French electorate, if I were running a small business in France I would probably plonk down a few points of my turnover on such a hedge, at least then if Royal won, I’d have a nice windfall to cover my increased taxes and administrative burden!
Carl Icahn agreed Monday to sell the Stratosphere, three other Nevada casinos and 17 acres of land on the Las Vegas Strip to Goldman Sachs Group’s real estate funds for $1.3 billion.
Ok ok, it’s a real estate play I know but still fun.
Buttonwood reports on the emergence of new, exotic asset classes such as…the football transfer market. Ie essentially providing venture capital for the development of new football players:
The football idea involves providing money to second-tier clubs (not Chelsea or Arsenal) to buy stakes in younger players. The fund then reaps a share of the rewards when the player is sold later in his career (footballers generally become more valuable as they approach their mid-20s). Why should clubs agree to this? Because they are usually short of money and can buy new players only by selling existing ones. By creating shares in their footballers, clubs can realise some of the equity in their human assets, without damaging the prospects of the team.
TechCrunchObsessively profiling and reviewing new web 2.0 products and companies.
TED BlogIdeas that matter in Technology, Entertainment & Design
the cluetrain manifestoThrough the Internet, people are discovering and inventing new ways to share relevant knowledge with blinding speed. As a direct result, markets are getting smarter—and getting smarter faster than most companies.
