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Trading futures on the Web's `prediction markets'

At simulated futures sites, users can wager fake money on the outcome of real events.

July 15, 2007|Matt Crenson | Associated Press

The issue of what constitutes gambling looms large over the future of prediction markets. The Pentagon's Defense Advanced Research Projects Agency learned that the hard way a few years back when it funded a few economists to set up experimental markets that would track America's national security interests in the Middle East. The markets would have allowed traders to buy futures contracts on measures of military activity, economic growth and Western terrorist casualties in eight Mideast countries.

The hope was that prices in the Mideast security markets might give U.S. intelligence officials a leading indicator of developments in the region. But the project was aborted in 2003 when members of Congress protested that it would allow people to gamble on terrorist attacks the way they would on a football game. Opponents objected to the possibility that people might profit from a terrorist attack, or that terrorists themselves might manipulate the market to their advantage.

Many skeptics argue that surveys work just as well or better than prediction markets in accumulating the knowledge of the masses. A recent study by Columbia University economist Robert S. Erikson compared the accuracy of the Iowa Electronic Market to that of public opinion polls during the 200 days leading up to the last five presidential campaigns.

Though he found the raw market predictions were generally closer to the election vote percentages, Erikson argued that the polls were better if you adjusted for things that they chronically misjudge, such as the incumbent's early advantage.

In other words, polls -- combined with the knowledge of an experienced pollster -- can outperform the market.

But even though he is skeptical about markets in the context of head-to-head presidential contests, Erikson thinks they have value in other situations, such as the free-for-all that is the early primary campaign season -- i.e., now.

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