Comments on: Roll the bones

By: pierre menard

pierre menard — Tue, 23 Dec 2003 19:19:28 +0000

Ted, About E: it is not necessarily a weakness. Lets say the price goes up as the market correctly senses an attack; the goverment makes some strong security increases. If these increases are insufficient—if the goverment is not doing enough—the price of the contracts will remain high. On the other hand, if the price drops the goverment can conclude that the security measures undertaken werent too bad. Yes, the price at any point will reflect future goverment actions. Its a good thing—a large spike in the price means that the market things the goverment is woefully unprepared and even if it takes some security measures as a result of this spike, an attack remains imminent. The point is that this gives the government some feedback—some ideas about how well its policies are faring. Its not getting that feedback now as the administration sees reflexive support from Republicans and reflexive criticism from Democrats.

By: pierre menard

pierre menard — Tue, 23 Dec 2003 19:11:56 +0000

About terrorists making money off the futures market: why not limit the participants to, say, all the publicly traded companies on US stock exchanges? This way terrorists won’t be able to make bets. However, the market would have to be well-regulated to prevent collusion among the players (as there are only about 10,000 publicly traded companies)

By: Pierre Menard

Pierre Menard — Tue, 23 Dec 2003 19:09:14 +0000

To Johnathan, who in the above post claimed that the whole idea is based on an irrational religious belief in markets: There is some convincing evidence that U.S. stock markets are fairly efficient, i.e. that the price of a stock at any given time is a not-too-bad reflection of its true value. For example, mutual funds fail spectacularly to beat the stock market in the long run. Mutual funds on average underperform the S&P 500, and there is in general no correlation between funds that outperform it over one period and funds that overperform it over the next. Obviously, the stock market is not perfectly efficient—it tends to crash once in a while and fluctuates a bit too much. Most economists do not believe the strong form of market efficiency—but no one can deny that the failure of money managers to beat the market indicates that market is reasonably efficient. In other words, collectively human beings seem to be able to determine the true price of stocks a lot better than individually. Which is why it might be a good idea to create a terrorism futures market: it could asses the risk of terror attacks better than any number of goverment analysts.

By: James Surowiecki

James Surowiecki — Sun, 21 Dec 2003 18:19:14 +0000

There is no theoretical or empirical support for the idea that you need “commercial hedgers” in a market in order for that market to be efficient. There are no hedgers in the market for horse-racing results, yet that market is remarkably good at predicting the outcome of horse races. Again, there are no hedgers in the IEM and it’s good at predicting the outcome of elections. Also, just as a side note: why not just look into the details of how PAM would have worked (some of the details were actually discussed in earlier posts on this thread and the previous one) before offering a critique of it?

By: rapier

rapier — Sun, 21 Dec 2003 11:42:16 +0000

I didn’t look into the details of how this was supposed to work but in general anything traded by futures contract has to be fungible, meaning any unit has to be the same kind and quality. Corn is traded weight (54 pounds is a bushel), by grade, USDA #2, which specifies moisture content, weight per volume (density), amount of broken kernels and other quality aspects. So in this market a car bomb blowing up a newstand would be the same as bringing down the WTC? Maybe this was addressed in the plan but I don’t see how it would work. The other nature of futures is that there are two kinds of participants. Commercial hedgers who take a position opposite one they have in the ‘cash’ market so as to lock in a price, and speculators. Hedging accounts for much of the open interest in futures contracts and acts as insurance for the commercials. A market in terrorism would be too small and inexact (see above) to provide any meaningful insurance so the market would be left to speculators. Without a practical use and therefore being simply a speculative tool a terror futures market becomes wrong on every level.

By: John S

John S — Sat, 20 Dec 2003 09:41:17 +0000

“If this is such a good idea, why haven’t the markets created it on their own?” Because gambling is highly regulated and creating such markets is often illegal even in the USA, never mind Europe. Stiglitz’s point about the risk of market manipulation when there are few participants is true of all markets. That’s not a killer blow.

By: self

self — Sat, 20 Dec 2003 05:58:09 +0000

joseph stiglitz, from http://www.commondreams.org/views03/0731-08.htm “But there are more fundamental problems with the idea. If trading is anonymous, then it could be subject to manipulation, particularly if the market has few participants — providing a false sense of security or an equally dangerous false sense of alarm. If trading is not anonymous, then anyone with information about terrorism would be, understandably, reluctant to trade on it. In that case, the market would not serve its purpose. Now consider the second function of futures markets — insurance. The Pentagon’s proposal would have allowed those with the sophistication and money to “hedge” against the threat of terrorism, financially at least, leaving the rest of Americans fully exposed! Though we have come to expect such inequities from the Bush administration’s tax policies, surely the U.S. government should be concerned with the exposure of all Americans to terrorism. Notice that in proposing this idea, at least the Bushies are recognizing the limitations of the innovative capacity of markets. If this is such a good idea, why haven’t the markets created it on their own? Interestingly, the group promoting the idea, DARPA, had — before Bush took over — a credible record of promoting some important innovations, including an important role in the early days of the Internet. In its own peculiar way, the administration has once again recognized the limitations of markets — as it did with the airline bailouts, steel tariffs and agriculture subsidies. But once again, the lack of intellectual foundation or a firm grasp of economic principles — or the pursuit of other agendas — has led to a proposal that almost seems a mockery of itself.”

By: Carlos

Carlos — Sat, 20 Dec 2003 03:47:29 +0000

Decnavda: My point is that markets are very good at producing new information (the prices of goods and services for example), especially when there is a lot of information to deal with and especially when participants in the market are influencing the probability of events (same example). When the markets work as pure analyists(sports gambling for example) my guess is that markets do much worse. I agree with the testing part, (science only progresses this way) but frankly I think that a futures market on serial killers would have a better chance.

By: Decnavda

Decnavda — Fri, 19 Dec 2003 22:50:02 +0000

Carlos- The markets would not produce new information, and all the methods you describe would still be needed. Rather, the markets would provide an honest amalgamation of the opinions of those with the access to the information you describe. The idea that the terrorists might invest losing money against their plans to throw people off the track is interesting, but it contradicts fears that they might try to use the markets to profit from their terrorism. These ideas are competing, but do not cancell each other out, and the best way to test them is to run an experimental market.

By: carlos

carlos — Fri, 19 Dec 2003 21:47:52 +0000

Having some former “terrorists” in my family (Uruguay, South America, 1968-1973) and knowing their organization and methods, I frankly found this idea ridiculous. The key of fighting “terrorist” organizations is good intelligence, secret information from an extremely small number of persons. ¿Can someone explain why markets can be more efficient in doing this than intelligence agencies? Unless you have a source inside, all the guesses in the world are useless. Besides, the terrorists themselves could play this game in reverse (attack or abstain contradicting market trends to provoke confusion).

By: decnavda

decnavda — Fri, 19 Dec 2003 21:12:36 +0000

jonathan- This “belief in markets = religion” smear from anti-market people has as much validity as the “belief in science = religion” smear that theists sometimes hurl at atheists. First, there are theoretical reasons, laid out above by james, as to why markets are efficient amalgamers of information. Second, belief in markets produces testable hypothoses. The Iwoa Electronics Market is one such test, and much of what we are doing here is debating the evidence that and other tests have provided. Tell me the theory is wrong, and why. Explain to me how I am misreading the evidence. Do not smear me as “religious”, or worse, “neocon”.

By: James Surowiecki

James Surowiecki — Fri, 19 Dec 2003 20:23:50 +0000

I disagree that this has much to do with the “marketplace” per se. I think it has to do with a faith that the collective judgment of a large group of motivated, diverse, relatively independent individuals is more likely to be correct than the judgment of a single expert or a small number of experts, no matter how well-informed. And I think the key is that it’s “more likely” to be correct rather than “always” right. (No economist would seriously argue the market is always right.) The real evidence for that proposition is overwhelming. Futures markets happen to be good ways of determining a collective judgment, because they provide incentives for people to uncover information, because the price of a futures contract is the weighted average judgment of all investors in the market, and because prices, if the contracts are written right, become direct representations of probabilities.But at its core (and I realize this is a somewhat heretical proposition) the logic behind PAM is roughly analogous to, for example, the logic behind Google.

By: Jonathan

Jonathan — Fri, 19 Dec 2003 19:59:29 +0000

The whole idea seems to be based on a basically religious belief in “The Marketplace” as a source of Truth. It seems to me that the originators of this didn’t see the information content as coming from real terrorists (since as Ted makes clear it would be very easy for fakes and frauds to dominate), but as coming from the marketplace—from the millions of decisions of millions of investors who, legend has it, always do the right thing in the aggragate. There is no more real evidence for that assumption than for the existence of God. It is simply one of the pseudo-religious beliefs of the neo-cons.

By: James Surowiecki

James Surowiecki — Fri, 19 Dec 2003 19:46:27 +0000

Sorry, the first sentence of that post is nonsensical. It should read: “The vast majority of the contracts that would have been offered on PAM had nothing to do with predicting specific terrorist attacks.”

By: James Surowiecki

James Surowiecki — Fri, 19 Dec 2003 19:45:03 +0000

I posted in the previous thread, but it seems relevant to Ted’s questions, so forgive the repetition: The vast majority of the contracts that would have been offered on PAM. They had to do with changes in civil, military, and economic conditions in the Middle East. This was the point of PAM’s partnership with the Economist’s Intelligence Unit. Indices of civil stability, military preparedness, and economic health would have been constructed, and the contracts would have been pegged, effectively, to changes in the indices. These are not contracts that could have been gamed by traders or used by terrorists to make money or that would demand a visit from the FBI. There would have been some contracts offered in discrete events — like, say, a coup, I gather — but they would have been more the exception than the rule. And again, I think most of them would not have been things that were obviously preventable or gamable, but that would nonetheless be very useful for the U.S. government to know about. At the same time, it’s probably true that a contract in something like “will a major terrorist attack occur on U.S. soil in the next two years” would have been offered. I don’t think the real problem to this one is B or D. There would be no contracts offered in anything as specific as “the TK building will be hit,” so there would be no chance to place small, long-shot bets and clean up. As for D, anonymity was, at least in theory, guaranteed. And if the market was useful, I’m not sure why it would be in the CIA’s interest to wreck it. I don’t really understand C, but if you mean that a speculator could manipulate the market by sending false signals, it’s of course a possibility but I doubt a profitable one. A) I don’t think was a problem, because PAM was going to be “the house,” effectively. It was going to take any trade, and I think it was going to construct standardized contracts which presumably would have defined what was meant by a “terrorist attack” or whatever The one real concern, I think, is E, though it applies, as I said, only to the discrete-event contracts. But I assume, as Ted suggests, that the market would price the possibility of an attack being foiled into its calculations. This wouldn’t defeat the purpose of the market because the intelligence agencies would be looking not just at the absolute level of prices but also, and perhaps more important, changes in price.