Sunday, March 12, 2006

"Prediction Exchange" Draft Paper

I recently completed a draft version of "The Prediction Exchange: Progress in Promoting the Sciences and Useful Arts." I've copied the abstract, below. You can download a PDF of the paper here. I invite you to check it out and give me your comments.

Among the paper's highlights:
  • The latest (and I daresay most complete) analysis of the legality of prediction markets under U.S. law;
  • A couple of tables that very helpfully illustrate the differences between prediction markets and the sorts of markets more properly regulated by commodity futures, securities, or gambling statutes;
  • Discovery of a new and very useful legal loophole for "hybrid instruments primarily securities"; and
  • The suggestion that the claims traded on prediction markets qualify as "negotiable conditional instruments," a legal animal impossible under Art. 3 but not unknown under common law.

Also, though I'm not sure it qualifies as a "highlight," the paper's conclusion might just might qualifymy craziest academic writing to-date. But, then again, law professors are well known to write some of the most stultifying prose on the planet, so the baseline for "craziest" isn't very high.
The Prediction Exchange: Progress in Promoting the Sciences and Useful Arts


Copyrights and patents promote only superficial progress in the sciences and useful arts. Copyright law primarily encourages entertaining works, whereas patent law mainly inspires marginal improvements in mature technologies. Neither form of intellectual property does much to encourage basic research and development. Essential progress suffers.

The prediction exchange offers another way to promote the sciences and useful arts. It would provide a forum for exchanging claims about unresolved questions of fact. Specifically, the prediction exchange would support transactions in a variety of prediction certificates, each one of which promises to pay its bearer in the event that an associated claim about science, technology, or public policy comes true. Like other, similar markets in information, the prediction exchange would aggregate, measure, and share the opinions of people paid to find the truth.

Because it would reward accurate answers to factual questions, a prediction exchange would encourage essential discoveries about the sciences and useful arts. Researchers and developers in those fields could count on the prediction exchange to turn their insights into profit. In contrast to copyrights or patents, therefore, a prediction exchange would target fundamental progress. Furthermore, and in contrast to copyrights and patents, the exchange would not impose deadweight social costs by legally restricting access to public goods. To the contrary, the prediction exchange would generate a significant positive externality: Claim prices that quantify the current consensus about vital controversies.

This article measures copyright and patent law against the Constitution's call for promotion of "the Progress of science and useful Arts," to find those traditional forms of intellectual property lacking. As a cure for that policy failure, it suggests the prediction exchange. Given that prediction exchanges offer large net public and private benefits, why don't they already thrive in the United States? Because the laws it applies to commodity futures, securities, and gambling markets cast a pall of uncertainty over prediction exchanges. To ease that unwarranted burden, the article explores a variety of strategies designed to guarantee the legality of prediction exchanges. The article concludes by putting theory into practice, backing up its claims about prediction exchanges with cold, hard cash.


Ben said...

It's quite interesting to frame it in terms of advancment of science. HI admit I have little knowlege of law but wouldn't scientists beting on their own research be comnsidered illegal insider trading or something? I mean if you are the one making a breaktrough experiment it be quite easy to place your bet after you know the results but before you publish them.

Tom W. Bell said...

Nah, Ben, that wouldn't be insider trading absent all sorts of other very strange conditions kicking in. I think we should welcome scientists to trade on the sort of "inside information" you have in mind. One of the main goals of a prediction market is to generate prices that aggregate and quantify scattered, private opinions.

(Of course, I'm not convinced that there is anything wrong with conventional insider trading, either. Except, of course, that it is illegal.)

Ben said...

You should make a post some day on the benefits of insider trading in general. I always assumed they were bad and frankly I can't see the advantages. I'd like to hear the arguments.

I mean with regard to science I can sorta see the logic in that allowing insider trading gives incentive to acquirer knowledge and since this coincide with the goal of science it could be considered useful. But with regard to other things I don’t see it. An insider selling because he knows in advance that his company is gonna tank is not the right kind of incentive.

It seems to me that it’s only fair that traders should declare their extra knowledge or at the very least the fact that they have this knowledge before they compete against others on the market.

Jadagul said...

It seems like insider trading could be okay if and only if the trader isn't an executive or something similar of the company in question. The CEO, for instance, shouldn't inside-trade for two reasons. First the practical one, that I could short piles of stock and then announce that I was going to do something phenomenally stupid. But more fundamentally, becuase executives and the CEO in particular have fiduciary obligations to their shareholders, and trading based on information that you have and they don't would seem to violate that.

On the other hand, for people who don't get to control the value of the company and don't have a fiduciary obligation to shareholders, insider trading helps update information on the value of the company much faster. It helps the market in its information-aggregation role by including more information—whatever the inside information is—into the calculation.

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