Picturing Financial Instruments

For my current writing project, I'd find it useful to develop a rough taxonomy of types of financial instruments. In particular, I'd like a graph clearly distinguishing securities, from commodities futures, from the sorts of claims traded on an prediction market. I want, in other words, something like a Nolan Chart for financial instruments. But I've not yet figured out what to put on the axes of such a Financial Instruments Chart.

To describe the problem more accurately, I have only some tentative ideas about what to put on the axes of a Financial Instruments chart. First, I know that I want axes that will allow me to clearly separate securities, commodities futures, and prediction market claims. Second, I'm pretty sure that the familiar "risk/return" ratio won't help on this chart.

Third, It seems likely that one axis should convey this fundamental distinction between securities and commodities futures: Securities markets create wealth by making capital available for productive purposes, whereas commodities futures markets preserve wealth by offering hedges against losses. All investors can gain in a rising securities market, just as all may lose in a sinking one. Futures markets, in contrast, pit each trader against another; no one trader can profit except at the expense of another, less predictive one. Securities markets amass wealth; futures markets transfer it.

On that view, one axis of the putative chart would convey whether a market offers positive-sum or zero-sum trading. (I here refer solely to intra-market effects; even futures markets, thanks to their useful hedging functions, offer to increase net social wealth when put in the context of a larger market.) That helps to distinguish securities from commodities futures and prediction market claims.

But, crucially for my project, prediction market claims would fall quite near commodities futures on the "positive sum v. zero-sum" axis of the financial instruments chart. How, then, to distinguish prediction market claims from commodities futures ones? I've got three ideas.

Shooting from the hip, I've hit on a couple of distinguishing features. First, prediction markets serve important expressive functions. Traders on such markets stake not just money, but their reputations and worldviews. Those who hedge on futures markets, in contrast, say little more than, "I think this instrument will counterbalance financial risks that I run in other markets." Second, prediction markets generate significant positive externalities. We care about claim prices not so much because they presage the future price of commodities sales, but because they quantify the current consensus about ongoing debates.

But, on reflection, I've shot some holes in those two candidates. A prediction market does not require its traders to trade expressively. They might trade for mere money, too. And futures markets' price-finding functions represent useful externalities, too.

I thus favor a third way to distinguish between prediction markets and futures markets: Prediction markets probably would not, and certainly need not, serve commercially significant hedging functions.

Even small-stakes and play money prediction markets do pretty well at quantifying the current consensus. Theory suggests that they would do better were some or more money at stake. Still, though, a real-money prediction market could serve important expressive and predictive functions even far short of the sort of capitalization required for the sort of significant commercial hedging that futures markets provide. Happily for this proposed way of distinguishing prediction markets from futures markets, a prediction market that hosts little hedging would by default offer almost pure expression. All who trade on such a prediction exchange would do so by dint of their beliefs—not merely because they aim to safeguard their portfolios.

What do you think? Would a chart like the one below prove useful?

            Financial Instruments Chart


expression |   prediction
           |     claims
           |                      securities
           |
           |
           |
 hedging   |    futures
          -|-------------------------------------
                zero-sum         positive sum