Removing the Legal Barriers to Prediction Markets

An team of economics all-stars -- including a couple Nobel laureates -- advocates in Science for the removal of legal barriers to establishing low stakes predictions markets in the US:

Several researchers emphasize the potential of prediction markets to improve decisions. The range of applications is virtually limitless--from helping businesses make better investment decisions to helping governments make better fiscal and monetary policy decisions.

Prediction markets have been used by decision-makers in the U.S. Department of Defense, the health care industry, and multibillion-dollar corporations such as Eli Lilly, General Electric, Google, France Telecom, Hewlett-Packard, IBM, Intel, Microsoft, Siemens, and Yahoo. The prices in these markets reflect employees' expectations about the likelihood of a homeland security threat, the nationwide extent of a flu outbreak, the success of a new drug treatment, the sales revenue from an existing product, the timing of a new product launch, and the quality of a recently introduced software program.

These markets could assist private firms and public institutions in managing economic risks, such as declines in consumer demand, and social risks, such as flu outbreaks and environmental disasters, more efficiently.

Unfortunately, however, current federal and state laws limiting gambling create significant barriers to the establishment of vibrant, liquid prediction markets in the United States. We believe that regulators should lower these barriers by creating a legal safe harbor for specified types of small-stakes markets, stimulating innovation in both their design and their use.

For those who don't know, prediction markets are like stock markets where you buy and sell shares based on your belief that a certain future event will occur. These markets pool the information of individuals traders and have been shown under a variety of circumstances to produce more accurate predictions than any one trader alone.

(For a summary of their costs and benefits, I recommend reading the excellent The Wisdom of Crowds by James Surowiecki.)

In spite of their benefits, many legal impediments exist to forming them in the US, most of them related to prohibitions on gambling. The authors cited specifically the Unlawful Internet Gambling Enforcement Act. They advocate the Commodity Futures Trading Commission (CFTC) -- which regulates markets of this nature -- creating safe harbor provisions to allow small stakes markets to come into being without fear of legal retaliation. (Of course, another option would be to remove the nanny-statist UIGEA altogether and allow the victim-less crime of online gambling to occur unmolested, but that would be simply ridiculous.)

Read the whole thing. The authors make a strong case for the use of prediction markets in academic settings.