A prediction market where insiders are swamped by suckers will still be helpful in amassing the bits of generally available information in a useful way.

And in any event, I think you could get a market of just insiders – it will operate as long as an individual insiders think their piece of info is better than the collective average. You would bet against other insiders if you’re one of them.

More subtly, lots of people believe that they’re better informed than all those other rubes out there. But that’s Charles MacKay (or Charles Kindleberger) territory. Or best left to the arguments between couples over the map on road trips.

Here’s a quick thought: how about a prediction market for Lotto results? I have the nagging sense that you could create one.

Still and all, I think Henry’s on to something w/his original post: if I knew that, even calibrating for fact that my knowledge as well as that of those whom I knew knew were somewhat fallible, there were people out there gaming the system, I’d be less likely to play (one particular reason why I think we should more tightly regulate investment banks’ M&A activities and disallow VCs/VC investees from serving on corporate boards).

Well so much the worse for modern economists then. Hayek’s actual point is a lot more subtle and doesn’t rely on the definition of “information” which was foisted on economics by Jon von Neumann after the second world war.

“Information, Trade and Common Knowledge”, with N.L. Stokey, 1982, JET (useful for the goff post above, as well as henry’s post)

as well as 20 years of theoretical implementation theory (and 10 years of financial experimental economics) on the informational efficiency of markets, the conditions for when it coincides with allocative efficiency and when it does not etc. For a taste, see here (say)

Journal of Economic Theory 39, 34-58

and here

Journal of Economic Theory 39, 14-33.

Daniel, to modern economists Hayek’s point only makes sense as a Stigliztian ‘private information’ model (or ‘asymmetric information’ – although private information is by definition ‘assymetric’). Henry’s original post misses the question of scale relative to market.

Look, you guys need to lose this hang-up about prediction markets: there might be many good reasons not to approve, from a policy perspective, the use of ‘prediction markets’ in certain contexts. That it is not based on sound economics (or is based on putative ‘antinomies’ within economics, and Henry tentatively tries to explore) is not one of them. As well, the policy justification for insider-trader laws, to the extent it can be justified, lies with the relationship of managment to the company (fiduciary duties etc), not out of concern for the efficiency of stock markets per se. As with much competition law, lawyers boldly go where economists fear to tread . . . .

Of course, by “very old”, I mean an argument that was published in leading journals (practically) before I was born. In particular, this was a key point in Sanford Grossman’s PhD thesis and in papers by Grossman and Joe Stiglitz.

Some references for anyone seriously interested:

1. “Information and Competitive Price Systems” (with Stiglitz), American Economic Review, 1976.
2. “On the Efficiency of Competitive Stock Markets where Traders Have Diverse Information” J Finance, 1976.
3. “On the Impossibility of Informationally Efficient Markets” (with Stiglitz), American Economic Review, 1980.
4. “An Introduction to the Theory of Rational Expectations under Asymmetric Information” Review of Economic Studies, 1981.

etc etc.

Cheers.

I think one interesting thought is that many of the people who think they have valuable information in reality don’t. Ie they think they know how things will go in spite of not having rock solid evidence. Sure people wouldn’t want to bet against someone who actually knows, but how many people actually know that the other person “knows”, and how often do they think that they “know” better?

If that made any sense, enjoy.

~Jon