and the UTILITY of PREDICTION MARKETS
TESTING OPPORTUNITY : 2008 ELECTION ODDS
OBAMA 90+% LIKELY to WIN
Election Prediction Markets Bet on Obama
by Ben Steverman / November 03 2008
Here’s one rare investment that, at least so far, has paid off handsomely in 2008: Barack Obama. Various election futures markets allow traders to make bets on politics. On Nov. 1, 2007, on the Iowa Electronic Markets, the Illinois senator was given about a 14% chance to merely win the Democratic presidential nomination. Today, traders are betting Obama has a 90% chance of winning it all by being elected president. Of course, the Republican nominee, Arizona Senator John McCain, could make a lot of money for certain investors by pulling off an upset on Nov. 4. As of midday on Nov. 3, the Iowa Electronics Market gives the Republican a roughly 8.8% chance of winning the presidency. Thus, if you bet on McCain for a “share price” of $8.80, you get a payoff of $100 if he wins. That’s a return of more than 1,000% if you’re right. Intrade also runs a presidential prediction market: It gives Obama a 92% chance and McCain a 9.5% chance of victory. Another site (not open to U.S. bettors) is Betfair.com, which gives Obama odds of almost 93% and McCain probability of about 8%.
How accurate are these markets? Many, including the founders of the Iowa Electronic Markets (see video below for more on IEM), say the collective wisdom of traders often beat the accuracy of polls in past elections. Ben Kunz makes the argument for prediction markets — both in politics and other fields like public health — in this BusinessWeek piece. On the IEM, you can bet on each candidate’s percentage of the popular vote. Right now, that gives Obama about 53.4% and McCain 46.8% of the vote. A key test of these markets will be how close this is to actual results. There are plenty of legitimate questions about how well these markets work. This fall, observers alleged that Intrade’s presidential futures market was being manipulated, creating odds that were inconsistent with (and more favorable to McCain than) other markets. Intrade’s CEO John Delaney investigated and said one institutional Intrade member had been making big buys that skewed the market. Delaney said the trader was trying to “manage certain risks.”
Alex Tabarrok at Marginal Revolution didn’t think this called into question the concept of prediction markets: “This supports Robin Hanson’s and Ryan Oprea’s finding that manipulation can improve (!) prediction markets – the reason is that manipulation offers informed investors a free lunch. In a stock market, for example, when you buy (thinking the price will rise) someone else is selling (presumably thinking the price will fall) so if you do not have inside information you should not expect an above normal profit from your trade. But a manipulator sells and buys based on reasons other than expectations and so offers other investors a greater than normal return. The more manipulation, therefore, the greater the expected profit from betting according to rational expectations.”
Even if markets get the liquidity they need to work efficiently, they have yet to prove they’re much more than an entertaining parlor game. These markets might be able to predict the obvious, but do they really tell us more than a statistically adept poll-watcher like Nate Silver or Chuck Todd? If working properly, the markets end up reflecting conventional wisdom. But they don’t really predict the future. A year ago, while Obama was given 14% of winning the Democratic nomination, McCain was given a 7.5% chance of winning the Republican nomination. Both “predictions” weren’t just wrong, but wildly so.
Furthermore, the usefulness of election prediction markets for investors as a so-called “risk manager” is questionable. First, the risks and benefits of an Obama victory should already be reflected in other markets. For example, health care stocks already have been hurt by the prospects for a successful Democratic effort to reform health care. Second, unless you expect to get a job in a McCain or Obama administration, the direct economic effect of a political outcome is not easy to determine. The impact of, say, the Indiana gubernatorial race (which you can also bet on at Intrade) is even harder to detect.
If you’re betting for McCain or Obama, in other words, it’s unlikely you’re trying to hedge against other losses if you lose. Rather, you’re probably just a political junkie having fun and trying to make a little money. More than 100 million people will vote for president, and each vote will have been determined by a multiplicity of factors. The complexity of it all is mind-boggling. The only thing that comes close to complexity of the factors that influence election vote totals is the many inputs that determine the price movements of a stock or other investment. And, as the past year has shown in both the presidential campaign and the stock market, life can be very unpredictable.
ROGUE TRADER / PROPAGANDIST TRIES to BULLSHIT MARKET
Trader Drove Up Price of McCain ‘Stock’ in Online Market
by Josh Rogin / Oct. 21, 2008
An internal investigation by the popular online market Intrade has revealed that an investor’s purchases prompted “unusual” price swings that boosted the prediction that Sen. John McCain will become president. Over the past several weeks, the investor has pushed hundreds of thousands of dollars into one of Intrade’s predictive markets for the presidential election, the company said. “The trading that caused the unusual price movements and discrepancies was principally due to a single ‘institutional’ member on Intrade,” said the company’s chief executive, John Delaney, in a statement released Thursday. “We have been in contact with the firm on a number of occasions. I have spoken to those involved personally.” After the internal investigation into the trading patterns, Intrade found no wrongdoing or violation of its exchange rules, according to the company. Citing privacy policies, Delaney would not disclose the investor’s identity or whether the investor was affiliated with any political campaign. According to Delaney the investor was using “increased depth” in the Intrade market “to manage certain risks.” The action boosted the McCain prediction over its previous market value and above the levels of competing predictive-market Web sites. Pundits and politicians have used Intrade to track the fortunes of the two presidential candidates. Through the site, begun in 1999 and incorporated in Ireland, traders buy and sell “contracts” that function as stocks, allowing investors to gamble on the outcome of political, cultural, or even geological events such as the weather. The company asserts and experts have found that the Intrade market is generally more accurate in predicting the outcome of major events than other leading indicators, including public opinion polls. But the relatively small scale of the market and its lack of outside regulation could leave the system vulnerable to unscrupulous investors, scholars of predictive markets say. Justin Wolfers, an associate professor at the University of Pennsylvania’s Wharton School of Business, said the trades in question do not follow any logical investment strategy. “Who knows who’s doing it, it’s obviously someone who wants good news for McCain,” said Wolfers, who has been following the situation closely. McCain campaign spokesman Michael Goldfarb said: “It’s always a good time to buy McCain.”
Intrade users first noticed something amiss when a series of large purchases running counter to market predictions sparked volatility in the prices of John McCain and Barack Obama contracts. The investor under scrutiny purchased large blocks of McCain futures at once, boosting their price and increasing the prediction that McCain had a greater chance of winning the presidential election. At other times, according to Intrade’s online records, blocks of Obama futures were sold — lowering the market’s prediction about Obama’s standing in the race. According to Intrade bulletin boards and market histories, smaller investors swept in to take advantage of what they saw as price discrepancies caused by the market shifts — quickly returning the Obama and McCain futures prices to their previous value. This resulted in losses for the investor and profits for the small investors who followed the patterns to take maximum advantage. The activities of the trader, dubbed the “rogue trader” on Intrade’s message boards, raised several questions. For example, the trader purchased large contracts named specifically after McCain and Obama. There were no similar-sized investments, however, in separate instruments that predict a generic Republican or Democratic presidential win — even though both sets of contracts apply to the same event, prices show. Some political news sites, such as realclearpolitics.org, prominently display Intrade’s McCain contract value but do not display the corresponding value for a Republican presidential win. Similar trading patterns were not found in competing predictive market Web sites betting on John McCain , such as the Iowa Electronic Markets or Betfair. This means the trader was paying thousands of dollars more than necessary to purchase McCain contracts on Intrade, where the price of betting on McCain was much higher. On Sept. 24, for example, Obama contracts were trading on
Intrade at a price that predicts a 52 percent chance of an Obama victory. At the same time, Betfair and IEM contracts equated to about a 62 percent chance of an Obama victory, according to the political site fivethirtyeight.com. Intrade records show the trader often purchased tens or hundreds of thousands of dollars of contracts in the middle of the night, when activity was at its lowest, and in large bursts. In a three-day period from Sept. 30 through Oct. 2, four separate flurries of buying drove the price of the McCain contracts up by 3 to 5 points each. Those numbers eventually settled when the market compensated. “These movements over McCain largely occurred at time when there was no way that any useful information came out that was pro-McCain,” Wolfers said. “A profit-motivated guy wants to buy his stock in a way that would minimize his impact on the price, a manipulator wants to maximize it.”
According to Intrade, the company contacted the investor and used public and private data held by the company as part of its investigation. That included an analysis of the trades made by the investor, tracking of Internet addresses, checking physical addresses and other information. Intrade released details about its investigation in a statement on its Web site. Some Intrade users commented on the company’s message board that the trader may believe in McCain’s chances for victory, despite trends in recent public opinion polls. Indeed, bucking conventional wisdom can be a profit-making strategy. For example, David Rothschild, a researcher and Ph.D. candidate at the Wharton School, said that during the first two presidential debates, the trader bet thousands of dollars on a McCain electoral victory at the same moment that instant polls were suggesting that Obama would win. “That’s equivalent to buying a company’s stock just as negative earning reports come out,” Rothschild said. “It is a bad investment, but may make some observers think that Mr. McCain won the debate, which, again would be the goal of market manipulation.” Also, the trader paid a premium of 10 percent to 20 percent on every dollar traded by not placing similar bets on other Web sites, according to Rothschild’s calculations. Overall, if the trader’s motive was to influence the Intrade market, he was remarkably successful, Rothschild said. The trader’s actions help keep the probability of Obama winning the election on Intrade about 10 percent lower than Betfair and IEM for more than a month. “If the investor did this as investment, not to manipulate Intrade, he is one of the most foolish investors in the world,” Rothschild said.
MARKET MANIPULATION RESEARCH
PROOF of CONCEPT?
“This is big news but not for the reasons that most people think. Although some manipulation is clearly possible in the short run, the manipulation was already suspected due to differences between Intrade and other prediction markets. As a result: “According to Intrade bulletin boards and market histories, smaller investors swept in to take advantage of what they saw as price discrepancies caused by the market shifts — quickly returning the Obama and McCain futures prices to their previous value. This resulted in losses for the investor and profits for the small investors who followed the patterns to take maximum advantage.”
This supports Robin Hanson’s and Ryan Oprea’s finding that manipulation can improve (!) prediction markets – the reason is that manipulation offers informed investors a free lunch. In a stock market, for example, when you buy (thinking the price will rise) someone else is selling (presumably thinking the price will fall) so if you do not have inside information you should not expect an above normal profit from your trade. But a manipulator sells and buys based on reasons other than expectations and so offers other investors a greater than normal return. The more manipulation, therefore, the greater the expected profit from betting according to rational expectations.
An even more important lesson is that prediction markets have truly arrived when people think they are worth manipulating. Notice that the manipulator probably doesn’t care about changing the market prediction per se. Instead, a manipulator willing to bet hundreds of thousands to change the prediction of a McCain win must think that the prediction will actually affect the outcome. And if people think prediction markets are this important then can decision markets be far behind?”
‘HERD INSTINCT’ as ECONOMIC MODEL
Why Do Markets Create Bubbles?
by Tim Harford / 10.21.08
Bubbles are like pornography: Everyone has his or her own opinion as to what qualifies, but it is impossible to pen a precise definition. If you wish to push the metaphor further, both are also fun for a while, if you like that sort of thing, but apt to end up making you feel deflated and embarrassed. Bubbles are also embarrassing for the economics profession. It’s not that we have no idea what causes bubbles to form, it’s that we have too many ideas for comfort. Some explanations are psychological. Some point out that many bubbles have been stoked not by markets but by governments. There is even a school of thought that some famous bubbles weren’t bubbles at all.
The psychological explanation is the easiest to explain: People get carried away. They hear stories of their neighbors getting rich and they want a piece of the action. They figure, somehow, that the price of stocks (1929) or dot-com start-ups (1999) or real estate (2006) can only go up. A symptom of this crowd psychology is that the typical investor displays exquisitely bad timing. The economist Ilia Dichev of the University of Michigan has recently calculated “dollar-weighted” returns for major stock indexes; this is a way of adjusting for investors rushing into the market at certain times. It turns out that “dollar-weighted” returns are substantially lower than “buy and hold” returns. In other words, investors flood in when the market is near its peak, tending to buy high and sell low. The herd instinct seems to cost us money. That is awkward for economists, because mainstream economic models do not really encompass “herd instinct” as a variable. Still, some economists are teaming up with psychologists and even neurophysiologists in the search for an answer.
Cambridge economist John Coates is one of them. He used to manage a Wall Street trading desk and was struck by the way the (male) traders changed as the dot-com bubble inflated. They would pump their arms, yell, leave pornography around the office and in general behave as though they were high on something. It turns out that they were: It was testosterone. Many male animals–bulls, hares, rutting stags and the like–fight with sexual rivals. The winner experiences a surge of testosterone, which makes him more aggressive and more likely to take risks. In the short run that tends to mean that winners keep winning; in the long run, they take too many risks. Dr. Coates wondered if profitable traders were also running on testosterone, and a few saliva samples later it appears that he is right. Profitable trading days boost testosterone levels and tend to encourage more risk-taking, more wins and more testosterone. When the risks didn’t pay off, the testosterone ebbed away to be replaced by a stress hormone, cortisol. The whole process seems likely to exaggerate peaks and troughs. These psychological explanations are likely to help us understand what goes on as bubbles form and how they might be prevented. Yet they make me nervous: It is too easy to blame a bubble on the mob psychology of the market when a closer look at most bubbles reveals that there is much more to the story than that.
For example, one famous early “mania” was the Mississippi bubble, in which countless investors poured their money into the Compagnie des Indes in France in 1720, and lost it. Yet there was more going on than a free-market frenzy: The government could hardly have been more closely involved. The Compagnie des Indes had effectively taken over the French Treasury and legal monopolies on French trade with much of the rest of the world (including Louisiana–hence “Mississippi bubble”). Investors were hardly insane to think that such a political machine might be profitable, especially since the king of France personally held many of the shares. But the king sold out near the top in 1720; within two years, the Compagnie was bankrupt and its political power dismantled.
The government played its own part in the current credit crunch, too. For all the scapegoating of deregulation, thoughtful commentators also point to the Federal Reserve’s policy of cheap money, and Fannie and Freddie’s enormous appetite for junk mortgages–urged all the way by politicians trying to make credit available to poor and risky borrowers. Market psychology was part of the story, but not the whole story. The idea that ordinary people have a tendency to be caught up in investment manias is a powerful one, thanks in part to Charles Mackay, author in 1841 of the evergreen book Extraordinary Popular Delusions and the Madness of Crowds. Mackay’s most memorable example was the notorious Dutch tulip bubble of 1637, in which –absurdity!–tulip bulbs changed hands for the price of a house.
It is the quintessential case study of financial hysteria, but it’s not clear that there was ever an important tulip bubble. Rare tulip flowers–we now know that their intricate patterning is caused by a virus–were worth huge sums to wealthy Parisian gentlemen trying to impress the ladies. Bulbs were the assets that produced these floral gems, like geese that laid golden eggs. Their value was no fantasy. Peter Garber, a historian of economic bubbles, points out that a single bulb could, over time, be used to produce many more bulbs. The price of the bulbs would, of course, fall as more were cultivated. A modern analogy would the first copy of a Hollywood film: the final copies may circulate for a few dollars, but the original is worth tens of millions. Garber points out that rare flower breeds still change hands for hundreds of thousands of dollars. Perhaps we shouldn’t be quite so sure that the tulipmania really was a mania. Economists are going to have to get better at understanding why bubbles form from a heady mix of fraud, greed, perverse incentives, mob psychology and government incompetence. What we should never forget is that underneath the apparent hysteria, there is often a cold rationality to it all.
the FOUR CONDITIONS of CROWD-MIND HEALTH
The wisdom of crowds you say? As Surowiecki explains, yes, but only under the right conditions. In order for a crowd to be smart, he says it needs to satisfy four conditions:
1. Diversity. A group with many different points of view will make better decisions than one where everyone knows the same information. Think multi-disciplinary teams building Web sites…programmers, designers, biz dev, QA folks, end users, and copywriters all contributing to the process, each has a unique view of what the final product should be. Contrast that with, say, the President of the US and his Cabinet.
2. Independence. “People’s opinions are not determined by those around them.” AKA, avoiding the circular mill problem.
3. Decentralization. “Power does not fully reside in one central location, and many of the important decisions are made by individuals based on their own local and specific knowledge rather than by an omniscient or farseeing planner.” The open source software development process is an example of effect decentralization in action.
4. Aggregation. You need some way of determining the group’s answer from the individual responses of its members. The evils of design by committee are due in part to the lack of correct aggregation of information. A better way to harness a group for the purpose of designing something would be for the group’s opinion to be aggregated by an individual who is skilled at incorporating differing viewpoints into a single shared vision and for everyone in the group to be aware of that process (good managers do this). Aggregation seems to be the most tricky of the four conditions to satisfy because there are so many different ways to aggregate opinion, not all of which are right for a given situation.
Satisfy those four conditions and you’ve hopefully cancelled out some of the error involved in all decision making: “If you ask a large enough group of diverse, independent people to make a prediciton or estimate a probability, and then everage those estimates, the errors of each of them makes in coming up with an answer will cancel themselves out. Each person’s guess, you might say, has two components: information and error. Subtract the error, and you’re left with the information.”
email : jamessuro [at] aol [dot] com
HOW CROWDS GET SMARTER
Q & A with James Surowiecki
Q: How did you discover the wisdom of crowds?
A: The idea really came out of my writing on how markets work. Markets are made up of diverse people with different levels of information and intelligence, and yet when you put all those people together and they start buying and selling, they come up with generally intelligent decisions. Sometimes, though, they come up with remarkably stupid decisions—as they did during the stock-market bubble in the late 1990s. I was interested in what explained the successes and the failures of markets, and as I got further into it I realized that it wasn’t just markets that were smart. In fact, crowds of all sorts were often remarkably wise.
Q: Could you define “the crowd?”
A: A “crowd,” in the sense that I use the word in the book, is really any group of people who can act collectively to make decisions and solve problems. So, on the one hand, big organizations—like a company or a government agency—count as crowds. And so do small groups, like a team of scientists working on a problem. But just as interested—maybe even more interested—in groups that aren’t really aware themselves as groups, like bettors on a horse race or investors in the stock market. They make up crowds, too, because they’re collectively producing a solution to a complicated problem: the bets of people betting on a horse race determine what the odds on the race will be, and the choices of investors determine stock prices.
Q: Under what circumstances is the crowd smarter?
A: There are four key qualities that make a crowd smart. It needs to be diverse, so that people are bringing different pieces of information to the table. It needs to be decentralized, so that no one at the top is dictating the crowd’s answer. It needs a way of summarizing people’s opinions into one collective verdict. And the people in the crowd need to be independent, so that they pay attention mostly to their own information, and not worrying about what everyone around them thinks.
Q: And what circumstances can lead the crowd to make less-than-stellar decisions?
A: Essentially, any time most of the people in a group are biased in the same direction, it’s probably not going to make good decisions. So when diverse opinions are either frozen out or squelched when they’re voiced, groups tend to be dumb. And when people start paying too much attention to what others in the group think, that usually spells disaster, too. For instance, that’s how we get stock-market bubbles, which are a classic example of group stupidity: instead of worrying about how much a company is really worth, investors start worrying about how much other people will think the company is worth. The paradox of the wisdom of crowds is that the best group decisions come from lots of independent individual decisions.
Q: What kind of problems are crowds good at solving and what kind are they not good at solving?
A: Crowds are best when there’s a right answer to a problem or a question. (I call these “cognition” problems.) If you have, for instance, a factual question, the best way to get a consistently good answer is to ask a group. They’re also surprisingly good, though, at solving other kinds of problems. For instance, in smart crowds, people cooperate and work together even when it’s more rational for them to let others do the work. And in smart crowds, people are also able to coordinate their behavior—for instance, buyers and sellers are able to find each other and trade at a reasonable price—without anyone being in charge. Groups aren’t good at what you might call problems of skill— for instance, don’t ask a group to perform surgery or fly a plane.
Q: Why are we not better off finding an expert to make all the hard decisions?
A: Experts, no matter how smart, only have limited amounts of information. They also, like all of us, have biases. It’s very rare that one person can know more than a large group of people, and almost never does that same person know more about a whole series of questions. The other problem in finding an expert is that it’s actually hard to identify true experts. In fact, if a group is smart enough to find a real expert, it’s more than smart enough not to need one.
Q: Can you explain how a betting pool can help predict the future?
A: Well, predicting the future is what bettors try to do every day, when they try to figure out what horse will win a race or what football team will win on Sunday. What horse-racing odds or a point spread represent, then, is the group’s collective judgment about the future. And what we know from many studies is that that collective judgment is often remarkably accurate. Now, we have to be careful here. In the case of a horse race, for instance, what the group is good at predicting is the likelihood of each horse winning. The potential benefits of this are pretty obvious. If you’re a company, say, that’s trying to decide which product you should put out, what you want to know is the likelihood of success of your different options. A betting pool—or a market, or some other way of tapping into the wisdom of crowds—is the best way for you to get that information.
Q: Can you give an example of a current company that is tapping into the “wisdom of crowds?”
A: There’s a division of Eli Lilly called e.Lilly, which has been experimenting with using internal stock markets and hypothetical drug candidates to predict whether new drugs will gain FDA approval. That’s an essential thing for drug companies to know, because their whole business depends on them not only picking winners—that is, good, safe drugs—but also killing losers before they’ve invested too much money in them.
Q: You’ve explained how tapping into the crowd’s collective wisdom can help a corporation, but how can it help other entities, like a government, or perhaps more importantly, an individual?
A: Well, the same principles that make collective wisdom useful to a company make it just as useful to the government. For instance, in the book I talk about the Columbia disaster, showing how NASA’s failure to deal with the shuttle’s problems stemmed, in part, from a failure to tap into knowledge and information that the people in the organization actually had. And in a broader sense, I think the book suggests that the more diverse and free the flow of information in a society is, the better the decisions that society will reach. As far as individuals go, I think there are two consequences. First, we can look to collective decisions—as long as the groups are diverse, etc.—to give us good predictions. But the collective decisions will only be smart if each of us tries to be as independent as possible. So instead of just taking the advice of your smart friend, you should try to make your own choice. In doing so, you’ll make the group smarter.
Q: When you talk about using the crowd to make a decision, are you talking about consensus?
A: No, and this is one of the most important points in the book. The wisdom of crowds isn’t about consensus. It really emerges from disagreement and even conflict. It’s what you might call the average opinion of the group, but it’s not an opinion that every one in the group can agree on. So that means you can’t find collective wisdom via compromise.
Q: What would Charles MacKay—the author of Extraordinary Popular Delusions and the Madness of Crowds—think of your book?
A: He would probably think I’m deluded. Mackay thought crowds were doomed to excess and foolishness, and that only individuals could produce intelligent decisions. On the other hand, a good chunk of my book is about how crowds can, as it were, go mad, and what allows them to succumb to delusions. Mackay would like those chapters.
Q: What do you most hope people will learn from reading your book?
A: I think the most important lesson is not to rely on the wisdom of one or two experts or leaders when making difficult decisions. That doesn’t mean that expertise is irrelevant, or that we don’t need smart people. It just means that together all of us know more than any one of us does.
EARLY CROWD EXPERIMENTS
by James Surowiecki
As it happens, the possibilities of group intelligence, at least when it came to judging questions of fact, were demonstrated by a host of experiments conducted by American sociologists and psychologists between 1920 and the mid-1950s, the heyday of research into group dynamics. Although in general, as we’ll see, the bigger the crowd the better, the groups in most of these early experiments—which for some reason remained relatively unknown outside of academia—were relatively small. Yet they nonetheless performed very well. The Columbia sociologist Hazel Knight kicked things off with a series of studies in the early 1920s, the first of which had the virtue of simplicity. In that study Knight asked the students in her class to estimate the room’s temperature, and then took a simple average of the estimates. The group guessed 72.4 degrees, while the actual temperature was 72 degrees. This was not, to be sure, the most auspicious beginning, since classroom temperatures are so stable that it’s hard to imagine a class’s estimate being too far off base. But in the years that followed, far more convincing evidence emerged, as students and soldiers across America were subjected to a barrage of puzzles, intelligence tests, and word games. The sociologist Kate H. Gordon asked two hundred students to rank items by weight, and found that the group’s “estimate” was 94 percent accurate, which was better than all but five of the individual guesses. In another experiment students were asked to look at ten piles of buckshot—each a slightly different size than the rest—that had been glued to a piece of white cardboard, and rank them by size. This time, the group’s guess was 94.5 percent accurate. A classic demonstration of group intelligence is the jelly-beans-in-the-jar experiment, in which invariably the group’s estimate is superior to the vast majority of the individual guesses. When finance professor Jack Treynor ran the experiment in his class with a jar that held 850 beans, the group estimate was 871. Only one of the fifty-six people in the class made a better guess.
There are two lessons to draw from these experiments. First, in most of them the members of the group were not talking to each other or working on a problem together. They were making individual guesses, which were aggregated and then averaged. This is exactly what Francis Galton did, and it is likely to produce excellent results. (In a later chapter, we’ll see how having members interact changes things, sometimes for the better, sometimes for the worse.) Second, the group’s guess will not be better than that of every single person in the group each time. In many (perhaps most) cases, there will be a few people who do better than the group. This is, in some sense, a good thing, since especially in situations where there is an incentive for doing well (like, say, the stock market) it gives people reason to keep participating. But there is no evidence in these studies that certain people consistently outperform the group. In other words, if you run ten different jelly-bean-counting experiments, it’s likely that each time one or two students will outperform the group. But they will not be the same students each time. Over the ten experiments, the group’s performance will almost certainly be the best possible. The simplest way to get reliably good answers is just to ask the group each time.
A similarly blunt approach also seems to work when wrestling with other kinds of problems. The theoretical physicist Norman L. Johnson has demonstrated this using computer simulations of individual “agents” making their way through a maze. Johnson, who does his work at the Los Alamos National Laboratory, was interested in understanding how groups might be able to solve problems that individuals on their own found difficult. So he built a maze—one that could be navigated via many different paths, some shorter, and some longer—and sent a group of agents into the maze one by one. The first time through, they just wandered around, the way you would if you were looking for a particular café in a city where you’d never been before. Whenever they came to a turning point—what Johnson called a “node”—they would randomly choose to go right or left. Therefore some people found their way, by chance, to the exit quickly, others more slowly. Then Johnson sent the agents back into the maze, but this time he allowed them to use the information they’d learned on their first trip, as if they’d dropped bread crumbs behind them the first time around. Johnson wanted to know how well his agents would use their new information.Predictably enough, they used it well, and were much smarter the second time through. The average agent took 34.3 steps to find the exit the first time, and just 12.8 steps to find it the second.
The key to the experiment, though, was this: Johnson took the results of all the trips through the maze and used them to calculate what he called the group’s “collective solution.” He figured out what a majority of the group did at each node of the maze, and then plotted a path through the maze based on the majority’s decisions. (If more people turned left than right at a given node, that was the direction he assumed the group took. Tie votes were broken randomly.) The group’s path was just nine steps long, which was not only shorter than the path of the average individual (12.8 steps), but as short as the path that even the smartest individual had been able to come up with. It was also as good an answer as you could find. There was no way to get through the maze in fewer than nine steps, so the group had discovered the optimal solution. The obvious question that follows, though, is: The judgment of crowds may be good in laboratory settings and classrooms, but what happens in the real world?
FRENCH TV DEBATE on CHARGING ALAN GREENSPAN with CRIMES
AGAINST HUMANITY at the HAGUE vs. STRINGING HIM UP
THIS GUY (PARIS)
vs. THIS GUY (USA)
email : max [at] maxkeiser [dot] com
and WHY NOTHING WILL LIKELY HAPPEN
Hunting for scalps / Oct 23rd 2008
The pressure for convictions is great but prosecutors have their work
Americans are turning creative as they strive to make sense of the crisis. On October 29th a group of artists will stage a “literal meltdown” by placing a 1,500lb (680kg) ice sculpture of the word “economy” in Manhattan’s Foley Square. The installation will, according to one collaborator, “metaphorically capture the results of unregulated markets.” For many, though, catharsis will come only through another capture: the arrest and courtroom humiliation of the erstwhile Wall Street titans the public holds responsible for the mess. In today’s political climate, the government will feel immense pressure to put a few moneymen in the dock. The FBI alone is probing more than two dozen firms. Market regulators, state attorneys-general and the Department of Justice are also jostling to unearth wrongdoing, sifting through e-mails and seeking whistle-blowers at firms such as Fannie Mae, American International Group and Lehman Brothers, the only Wall Street firm allowed to go bust. At least 17 former Lehman executives, including Dick Fuld, once its boss, are expected to receive grand-jury subpoenas.
Investigators are likely to focus mainly on disclosure and valuation. Ken Lay, boss of Enron, the failed energy giant, was convicted in part because of upbeat public statements he made even as he knew the firm was in trouble. Some may try to draw a parallel with Lehman, which said its capital position was “strong” just days before it filed for bankruptcy. But to constitute fraud there must be intent to deceive. Proving that beyond reasonable doubt may not be easy, even to a jury disinclined to give fat cats the benefit of the doubt. Likewise, sloppy risk management, though lamentable, is not illegal. Paradoxically, the severity of the financial storm could help defendants. “As the crisis has grown, it has become harder for prosecutors to charge that any single firm has committed fraud,” argues Robert Giuffra of Sullivan & Cromwell, a law firm. Moreover, showing that executives deliberately overvalued complex mortgage securities could be hard. Those accused of masking losses can point to the continuing debate over mark-to-market rules, which regulators recently relaxed—though any e-mails that reflect internal doubts about marks could “create smoke”, says Mary Jo White of Debevoise & Plimpton, another law firm.
The legal climate has shifted in favour of corporate defendants, too. Some aggressive tactics used by prosecutors after the bursting of the dotcom bubble have been curbed: for instance, firms can again cling to attorney-client privilege—the right to keep their communications confidential—without it being viewed as unco-operative by the authorities. New sentencing guidelines means 25-year jail terms are less likely. In civil cases three Supreme-Court rulings have made fraud harder to prove. Investigators are yet to turn up clear evidence of unethical behaviour, let alone anything that warrants a long stretch in jail. They have a lot more digging to do—witness the subpoenas just handed to analysts who covered Lehman, requesting information that might suggest they were misled. They may find dirt—but it will be harder to make it stick.
WHO’S MAX KEISER? (WIKI WON’T SAY)
SIMPLE SOLUTION to WIKI ‘NOTABILITY’ PROBLEM:
EVERYONE MENTION MAX KEISER (NOW HE’S FAMOUS)
a vote to keep: “I added some, not all, of the material on the Max Keiser entry and there was at one point an explanation of the significance of the underlying patent on HSX. It was however deleted. The three underlying patents which are still linked to in the article, I believe, are the only patents for prediction markets and virtual currencies. The virtual specialist technology he invented is a mechanism for creating a price for previously unpriceable things like fame, popularity, ideas, time spent online, etc. Prediction markets were called the biggest financial and market trend for the future by the Economist Magazine (December 2005). So, his virtual specialist technology is notable to economics and finance even if the average person doesn’t understand the notability. The debate held between Keiser and the Hollywood studios in the public during 1999 when Keiser said studios were going to have to compete with a ‘price point called free’ was revolutionary at the time. From the Hollywood industry trade magazines linked to in the article, it is clear to see that no other person had suggested this publicly at that time and it was considered heretical as the articles make clear. In terms of Karmabanque not being relevant, Cheuvreux, a major European bank, only just came out with a report this month, June 2007, called “Consumer Power: Pricing Power versus Consumer Power” and the report specifically cites Max Keiser alone as having innovated a powerful market solution to the demand side of the consumer / corporation equation with Karmabanque. And Newsweek Japan is profiling Max Keiser and Karmabanque for the final issue of June 2007. The Karmabanque Hedge fund concept is the first ever mechanism for monetizing dissent in a day and age of anti- globalisation protests where hundreds of thousands protest G8 like events. Karmabanque has been profiled in the Washington Post, Dow Jones Marketwatch, Atlanta Journal Constitution and dozens of other important financial trade magazine and has been included in the curriculum at universities (Robert W. Benson, Loyola Law School) as well as legal opinions issued by the Washington Legal Foundation. So, while it may not be easy for the the average person to understand the significance at this moment in time, it is notable in financial, market, banking and academic sectors – all of which also use Wikipedia. And, finally, Max Keiser is an American presenter for Aljazeera English. He has made six films for them and most of the films are linked to in the article. Aljazeera English is a notable international broadcaster with significance at this moment in history.”
the COLLECTED LETTERS to EDITOR of MAX KEISER
MANIPULATION RUINS (PREDICTION) MARKETS
Prediction markets are doomed to fail / June 6 2008
From Mr Max Keiser.
Sir, I predict that if John Authers keeps quoting prediction markets in his columns (“Recession fears”, The Short View, June 3), their ability to generate reliable price signals will diminish as those in a position of power will try to subvert these markets with “spin” and PR, as they do now on various other markets. I had this experience when I was running the Hollywood Stock Exchange, the first and most influential of all prediction markets. When I predicted box office success, the networks (which also own film studios) would broadcast that information. When I predicted box office losers, they chose to ignore it. Naturally, we tended to talk up MovieStocks that looked as if they were going to be winners, and this ended up defeating the whole purpose of having a prediction market.
75005 Paris, France
Former Chief Executive and Co-Founder, HSX Holdings/ Hollywood Stock Exchange
STOCK PRICE VACUUMS
June 27 2008
From Mr Max Keiser.
Sir, The opposite of a stock price bubble is a stock price vacuum. Just as stock prices are inflated to a point where the tiniest prick of reality can pop the bubble and cause a wave of selling, stock prices that are driven lower by rampant, unfounded short-selling can snap back with a rally as soon as the oxygen of buyers emerges to eliminate the price vacuum.
75005 Paris, France
MARKET OPAQUENESS — “OFF BALANCE SHEET”
Transparency is the essence of market economy
by Max Keiser / June 29 2007
From Mr Max Keiser.
Sir, Martin Wolf makes a good case for reforming capitalism (“Risks and rewards of today’s unshackled global finance”, June 27) but fails to address the key problem underlying the various inequalities and distortions he describes. Transparency used to be the hallmark of market economics. Buyers and sellers had confidence in the “invisible hand” of multiple self-interested parties seeking maximum utility for themselves – and, in so doing, inadvertently contributing to fair prices. Today the business of market-making, the so-called price discovery mechanism at the heart of every exchange in the world, is dominated by “black box” algorithmic proprietary trading models of unregulated hedge funds and private equity that thrive on market opaqueness. These private funds argue that to become transparent would mean giving away trade secrets. In other words, the very essence of free market capitalism, transparency and fair play, has gone “off balance sheet” as surely as those hundreds of billions of dollars worth of misplaced synthetic derivatives we keep reading about. Until these fund managers are forced to disclose the actual risk they carry, we cannot expect the situation to rectify itself before being forced to do so with an inevitable “exogenous” repricing event like the one we saw in October of 1987.
Founder and chairman,
Karma Banque, Paris 75005, France
Problem with banks was insolvency / November 28 2007
From Mr Max Keiser.
Sir, Lawrence Summers needs to wake up and smell the inadequacies of his analysis (“Wake up to the dangers of a deepening crisis”, November 26). Two months ago (“Beware the moral hazard fundamentalists”, September 24) he was trying to convince us that the problem with banks was not insolvency but rather illiquidity. Insightful observers of the credit markets knew then, as they know now, that the primary source of revenues for much of the banking industry for the past decade has been their foolhardy participation in a global Ponzi scheme backed by what we now know to be largely counterfeit mortgage paper. Therefore it is insolvency along with its corollaries – opacity, misleading statements, dishonesty and larceny – that constitute the problem and illiquidity that is its symptom.
Founder and Chairman,
Karma Banque, Paris 75005, France
‘Integrity’ blinding environmentalists
by Max Keiser, Financial Times / Jan 02, 2004
From Mr Max Keiser.
Sir, Allow me to comment on your editorial “Not so great revolt” (December 30). I started a website 18 months ago that recommends to all activists, not just shareholder activists, how to take positions against corporations based on a company’s highest point of vulnerability, its stock price. To this end, we offer an index that lists which companies’ stock prices are the most vulnerable to a boycott, the low-cost weapon of choice for most activists. What I have discovered during this time sadly confirms what I construe to be the FT’s findings, that activists are blind when it comes to recognising the potential of targeting a company’s stock price in their campaigns. In the case of the environmentalists I have talked to, I can report that the reason they refuse to look at the world in this way is because they consider talking about markets and money as the basis for a campaign to be beneath their integrity as moral guardians of the ecosphere. They would rather be hauling buckets of sludge and tar off a beach in Spain or Alaska than working to clean up the environment of finance, even though companies have proved many times over they do not care as much about oil-drenched rare birds as they do about their stock price. Hedge funds, interestingly enough, send me e-mails every day asking when activists will launch a stock-price targeted campaign so that they can start shorting shares in these companies – this implies that activists have an incredible leverage in this economy to effect change, leverage they are not making use of, simply because their high-minded definition of the environment refuses to include the environment of money and markets.
Max Keiser, Chairman and Founder
Karmabanque, Villefranche Sur Mer 06230, France
Anti-Americanism: the ‘third way’
by Max Keiser / Financial Times / Feb 26, 2003
From Mr Max Keiser.
Sir, Moisés Naím’s commentary (“Anti-Americanism’s nasty taste”, February 24) describes two types of pernicious anti-Americanism: murderous fanatics who want to destroy America; and those who just want to rant, a group he calls anti-Americanism “light”. Both groups, he says, create an unacceptable cost of fanning the flames of animosity towards the US and therefore should be avoided. I wholeheartedly disagree and offer a third version of anti-Americanism, one that I feel is necessary now that the US has wilfully abdicated its leadership role in matters of universal global seriousness, such as protection of the environment. In my opinion, the US no longer qualifies for the type of critical exemption suggested by Mr Naím. The US voluntarily stepped down from the pedestal of moral accountability when Bush took office and walked away from various international treaties and organisations. Therefore, it stands to reason that the US must now deal with the consequences of living in a world that views its franchise not as a perennial force for good but as just another economic entity either to buy or to sell. As an American, I am expressing my anti-Americanism by selling short the Standard & Poor’s 500 and I will continue to do so for as long as America’s rhetoric about maintaining social contracts such as freedom and democracy races ahead of its actions in places such as the Gulf. I will gladly cover my shorts when the US starts to act like a country that believes in democracy instead of one that just talks about it. If every hedge fund manager in the world focused his collective market power in this way I believe the US would be forced to change its behaviour or risk getting “decapitalised” in a non-violent, non-fanatical way, a third way not mentioned by Mr Naím in his commentary.
Max Keiser, Co-founder, Chairman, Karma Banque, Villefranche-sur-Mer, France
NGOs would do well to become more transparent
by Max Keiser / Financial Times / May 26, 2004
From Mr Max Keiser.
Sir, Rational cost accounting, economies of scale and cost-benefit analysis, as Bjorn Lomborg suggests (“The Copenhagen Consensus will help save lives”, May 24) comprise a long-overdue development in the field of activism. Until morality starts trading on one of the main exchanges it is impractical to think that the moral argument used by virtually all non-governmental organisations will sway the behaviour of those who run socially irresponsible companies. Activists arguing against Mr Lomborg’s ideas seem to think that putting a dollar value on their activities is tantamount to cheapening the importance of what they are trying to accomplish. Is this not the inverse of the same argument corporations use to legitimise their irresponsible behaviour; that trying to put a dollar amount on morality reduces their ability to serve shareholders by pursuing, as Milton Friedman might say, maximum profit? Perhaps activists are being disingenuous. They seem to be putting up a smoke screen when more transparency is in order. In other words, is it possible that cost-efficiency, if embraced by the thousands of NGOs that are now operating without basic economic principles, might lead to the realisation that the structure of NGOs themselves is as inefficiently bloated as the corporations they criticise. NGOs seem to be saying they are against Mr Lomborg’s methods, but I think what they are really saying is they are against losing their jobs.
Max Keiser, Chairman and founder,
Karmabanque, Villefranche-sur-Mer, France 06230
Hedge Funds Banking on Social and Moral Issues
by Thomas M. Kostigen / December 25, 2004
Wealthy British scion Zak Goldsmith and investment activist Max Keiser want to take down Coca-Cola Co., and they have added a new twist to the age-old tactic of boycotting: They have opened a hedge fund designed to profit from any decline in the soft drink conglomerate’s stock price. “We’re simply picking up on a trend and giving people the tools to use,” Keiser said. “The Internet allows people, activists, from all over the world to gather, or swarm, and hit a company where it hurts most — in their stock price.” Hedge funds are a popular investment option for the wealthy. But creating a hedge fund with a specific social agenda, like the one promoted by Goldsmith and Keiser, is a recent development, according to Doug Wheat, director of business development at SRI World Group, a financial news and data monitoring service in Vermont. “There are only five or six hedge funds like that,” Wheat said. “Meanwhile, there are like 8,000 hedge funds.” A hedge fund is a type of private investment vehicle for wealthy investors who choose to pool their money and invest in securities. Many hedge funds invest in unusual securities in unusual ways. They sometimes assume substantial risks on speculative strategies. This sometimes includes “hedging,” or leveraging investments to get the most gain. Hedge funds are subject to few regulations. The Securities and Exchange Commission requires only that the investors be accredited, meaning that they must earn more than $200,000 per year or have a net worth of more than $1 million. Hedge fund managers are not currently required to register with the SEC. “We don’t get into who’s investing,” said SEC spokesman John Heine. But that hands-off approach may change. Regulators started eyeing hedge funds after the 1998 near-collapse of Long-Term Capital Management LP, which lost billions in derivatives trading and created a financial market disaster, necessitating a private-sector bailout organized by the Federal Reserve Bank of New York. In October, the SEC voted 3 to 2 to increase hedge fund oversight by mandating that hedge fund managers register by February 2006. But on Monday, the head of a New York-based hedge fund, Opportunity Partners LP, sued the SEC in an effort to block the registration requirement. In public comments dissenting from the adoption of the proposed registration rule, the two Republican commissioners, Cynthia A. Glassman and Paul S. Atkins, questioned whether the registration requirement would be too rigorous on certain issues and too lax on others. Heine said that requiring hedge funds to register with the commission “will not have any effect on the suitability requirement for hedge fund investors.” Even within the context of traditional stock and bond investing, hedge funds sometimes seek out esoteric niches, such as interest rate swaps and collateralized mortgage obligations, according to Todd Goldman, managing principal at Walnut Creek, Calif., accounting firm Rothstein Kass, which serves hedge funds. “The whole point of hedge fund investing is the ability to specialize,” Goldman said, pointing out that there are hedge funds producing steady returns that strictly invest in credit card debt and funds that invest in tax liens. To date, specialization among hedge funds has meant inventing new investment strategies within a core group of publicly trade securities — stocks, bonds, currencies, futures and options. But some investors are expanding beyond what most people would even consider investments. Billionaire Mark Cuban, owner of the NBA’s Dallas Mavericks, for example, said in November that he is preparing to launch a hedge fund focused on gambling. “This hedge fund won’t invest in stocks or bonds, or any type of business. It’s going to be a fund that only places bets,” Cuban said in a posting on his Web log, MarkCuban.com. He promised in his posting to hire top professional gamblers to figure out what bets to place or what games to play. Their performance of gambling wins and losses, of course, will generate the return for investors, Cuban said. He declined to comment further on his hedge fund plans in response to an e-mail message from The Washington Post on the subject. Some funds already invest in the gaming sector, albeit through trading shares of companies operating in that industry. The Vice Fund, based out of Texas, for example, is a mutual fund that invests only in companies with ties to weaponry, smoking, drinking and gambling. Other funds take great pains to avoid so-called “sin” stocks. Shariah Funds, managed by Meyer Capital Partners of New Canaan, Conn., invests according to Islamic law, avoiding companies associated with gambling, alcohol, tobacco and food processing (because of dietary restrictions). “We look at a company’s primary business first, and then we look at their financials,” said Sheikh Yusuf Talal DeLorenzo, an Islamic scholar and adviser to the fund. DeLorenzo noted that although Islamic law prevents the taking of interest and allows investments only in tangible assets, he has configured a way to hedge using futures and options. The money behind Shariah Funds comes from wealthy investors in the Middle East and Asia, DeLorenzo said. Other groups with religious affiliations have also launched hedge funds. Last year, Catholic Institutional Investors, a coalition of five Catholic health care organizations, launched the Good Steward Fund. And the Church of Jesus Christ of Latter-day Saints has a private investment fund — Ensign Peak Advisors — to serve its Mormon constituents. Mission-oriented hedge funds fall into a category known as “socially responsible” investments that permit investors to grow financially while still adhering to their own individual social or moral preferences. Investment managers typically screen potential investments so that they match a client’s beliefs. Socially responsible investing is one of the fastest-growing sectors in the financial services industry, with more than $2 trillion of assets being managed in such fashion, according to the Social Investment Forum, a District-based nonprofit organization providing research and education. The anti-Coke campaign has been called by its founders a “smart boycott.” Goldsmith said he believes he can push Coca-Cola shares to as low as $22. They closed at $41.51 in Thursday trading on the New York Stock Exchange. U.S. financial markets were closed yesterday. “Coke represents the cutting edge of a global monoculture that is undermining real human diversity,” said Goldsmith, 29, who is the son of a famed British corporate raider, the late Sir James Goldsmith. With a reported inheritance of about $700 million, Goldsmith could wage a formidable battle against Coca-Cola via his family’s magazine, the Ecologist, where he is founding editor. Coca-Cola has issued numerous statements clarifying its positions on the corporate issues at which Goldsmith and Keiser are taking aim. “This so-called campaign is based on blatant falsehoods,” said Ben Deutsch, a Coca-Cola spokesman. “It’s unfortunate that anyone would attempt to hurt Coke shareholders . . . without the facts.” Investors in the unnamed anti-Coca-Cola fund will get a stated annual return akin to a long-term Treasury bond. But, after a 2 percent management fee, the rest of profits will go to aid disaffected farmers in India, AIDS organizations in Africa and human rights monitoring groups in Central and South America. “We’re now focused on closing a $100 million fund by the end of 2005,” said Keiser, who founded Karmabanque.com, the Web site through which the anti-Coca-Cola campaign is being managed.
MAKING A MARKET
An Internal Futures Market
by Robert Charette / March 2007
“The economic problem of society is thus not merely a problem of how to allocate “given” resources … it is a problem of the utilization of knowledge which is not given to anyone in its totality.” Friedrich Hayek, the 1974 Nobel Prize winner in economics, wrote these words in his 1945 classic essay, The Use of Knowledge in Society, in which he argued that centrally-planned economies are unable to efficiently allocate societal resources because their planners, no matter how smart they were, would never have all the information required to make the correct decisions. Hayek, on the other hand, asserted that pricing systems, (e.g. stock markets), which reflect the collective knowledge of a myriad of individuals is a much better approach for performing resource allocation decisions. Market systems which signal the value of a resource through a numerical index (i.e. price), he said, are “a mechanism for communicating information”, with the “most significant fact about this system [being] the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action.”
The problems that Hayek said governments face in best allocating resources are nearly identical to what most organizations face. How can the corporate planners have access to all of the information they need to best allocate scarce corporate resources to increase shareholder value? And, as Dominic Dodd and Ken Favaro, in their book, “The Three Tensions,” point out, is the best way to increase shareholder value to increase corporate profitability or growth? Allocate resources for results today or tomorrow? Allocate resources to increase the performance of the corporation as a whole or performance of standalone business units? Could it be some combination of all six?
The Future Value of Decisions
The growth of business intelligence over the past decade reflects the idea that corporate planners – be they on the corporate executive staff, business managers or line managers – need better information to make their allocation decisions, and properly structured BI can often help fulfill this need. However, the focus of BI in many instances seems to be more on answering questions about “what was” or possibly on “what is,” data that reflects the past or recent past – rather than on what will be. The current focus on BI corporate dashboards is an example. What planners truly need is information about “what might be.” – i.e., what is the future value of present decisions?
Markets systems fit this bill nicely since they are focused primarily towards predicting the future. A corporation’s stock price, for instance, reflects not only information about the corporation’s current course and speed but also its projected course and speed as perceived by its current investors and non-investors alike. When a corporation releases its quarterly earnings and investors react positively or negatively, for example, they are making a collective judgment on the corporation’s future financial risks, not its current state of play.
It has long been recognized that collective judgment provided by market systems can be very useful in making accurate predictions about future events, but it has only been in the past 30 years or so that “maverick” economists such as Vernon Smith (who won a Nobel prize in economics in 2002), Charles Plott, John Ledyard and Robert Forsythe have focused on how to use the predictive power of markets for uses other than for managing financial risk. As detailed in James Surowieki’s recent book, “The Wisdom of Crowds,” the theoretical work of these four economists, combined with Internet’s ability to quickly form markets, has spawned the creation of a number of prediction/ information markets, like Forsythe’s Iowa Electronic Market, which is used to predict elections, TradeSports in Ireland which focuses primarily on sporting events, and the Hollywood Stock Exchange, which focuses on the various goings-on of the film industry.
Market Systems and the Enterprise
In conjunction with using markets for “public” prediction purposes, a number of economists have investigated the use of predictive markets that also could be used by corporations internally. Economist Robin Hanson (who studied under Plott), came up with the concept of the idea or innovation future market, where specific questions of some future event could be evaluated for its likelihood of occurrence. One question of interest, Hansen says, might be the probability that the greenhouse effect and other causes will have raised the average world sea levels by 1 meter by 2030. By establishing a market focused on that question, a rapid consensus – in the form of a probability that is related to the going market price – can be reached about this
Over the past decade, a small but growing number of companies have been creating their own internal idea, innovation or prediction markets. For instance, France Telecom Group created an internal predictive market called Project Destiny that examines certain technological trends. A France Telecom employee is able to place bets concerning different technology questions, for example, will Skype reach “X” million of users by a given date? France Telecom believes that by posing questions whose outcome can affect its business, executives and managers can be better prepared to address them. Of the 18 questions posed, Project Destiny claims its internal market to have correctly predicted 16 of them.
Similarly, Yahoo, in a joint venture with O’Reilly Media, has created a prediction market called the Tech Buzz Game. The game is made up of a number of sub-markets that match a small number of rival technologies against one another, Internet browsers for instance. The object of the game is to anticipate a technology’s “buzz” as measured by the number of Yahoo!Search users seeking information about that individual technology. Yahoo hopes by conducting this game it can evaluate whether power of prediction markets can help forecast high-technology trends.
Google has created an internal predictive market that according to Google, aims to “forecast product launch dates, new office openings, and many other things of strategic importance to Google.” Google says that over 20 percent of its staff has bid in the 100-plus online markets it has run, covering over 350 events in more than 40 different topic areas. Google says that the online market prediction accuracy is about 70 percent.
HP Labs created its own internal market system and supporting software called BRAIN (Behaviorally Robust Aggregation of Information in Networks) to help predict certain critical business issues such the quarterly sales forecast or the price of DRAM memory chips in one, three or six months. The importance of being right about a forecast can have major impact. If a chip price forecast is off by just a couple of pennies, a significant impact on HP’s hardware profit margin can result. HP has found that its internal market predictions are often more accurate than the company’s “official” forecasts (for instance, six out of eight times the market was better at predicting computer sales). HP is now working with Pfizer pharmaceutical to create an internal prediction market using BRAIN starting in 2007.
Many other companies are experimenting with or creating different types of internal prediction markets: Microsoft (for predicting product ship dates); GE (for discovering new ideas); Eli Lilly (for discovering new drug candidates); BP Amoco (for reducing carbon-dioxide emissions); Intel (for allocating computer chip production), and; Siemens AG (for improving the accuracy of product developments). As these companies and others report their experiences with the application of internal prediction markets, it is likely that others will follow suit.
Making a Market
For internal markets (or any market for that matter) to work well, a number of requirements must be met. First, there has to be a diversity of opinion: the more diverse the opinion, the better the prediction. Second, the market participants need to have independent opinions. If these first two requirements are not met, you tend to get a “group think” result. Third, decentralized information sources need to exist, in other words, unique levels of knowledge should be held by the market participants. Finally, the information from everyone needs to be aggregated in some way. A stock’s price, as Hayek says, serves to aggregate information. If these are not met, then the prediction value of the market starts to decline.
While the concept of using internal predictive markets is very seductive, their use should not be seen as end-alls or be-alls. As Max Keiser, the inventor of the technology that runs the Hollywood Stock Exchange, warns, “Markets (are) unable to forecast the future with any certainty.” This can readily be seen from just a couple of the examples cited above. They are generally better than other predictive measures, such as polling or Delphi techniques, but they shouldn’t be endowed with powers they don’t have.
Furthermore, while markets may be good at predicting certain events, they don’t tell you “why” events are going to happen. For instance, some companies have used internal markets to predict software delivery schedules, which proved more accurate than the internal estimates. However, “the market” couldn’t indicate why the software was going to be delivered late – or how the development approach could be improved so that future delivery dates could be met. It may be that by using BI analytics with prediction markets this issue could be addressed.
As far as I am aware, no one has tried to tie BI in with the use of prediction markets, but it would seem to be a very natural fit. For instance, access to BI systems could allow some market participants to increase the level of decentralized or special knowledge (think insider trading information), which could help improve market predictions. Or, BI’s ability to aggregate corporate information in novel ways could be used to help create interesting questions for an internal market to contemplate (remember, markets don’t ask questions – someone else has to). Or, from a risk management perspective, an internal market used with BI analytics could help increase the understanding of how to manage the three elemental tensions – profitability or growth, results today or tomorrow, synergistic or stand alone performance – better or to create improved contingency plans based as a result of a set of internal market predictions. Internal prediction markets are only in their infancy, but I expect them to become more common in the next decade. For those in the BI field, now is a good time to see how BI and market information can be tied together.
COMEDY or TRAGEDY? MAX KEISER (cont.)
U.S. DOLLAR is a ‘TOXIC CURRENCY’
MIDDLE EAST GOLD-BACKED CURRENCY in DEVELOPMENT
CRASHING the DOLLAR
BETTING on IRAN WAR, etc.
the CARRY TRADE (ICELAND, 2007)
ONLINE POLITICAL BETTING
Playing Virtual Markets / July 11, 2001
Regarding the report “Just a Game? Some Virtual Traders Aren’t Playing
Around” (July 7):
It is true that virtual markets are better at predicting outcomes than polls, but markets are horrible predictors of anything. If the markets did not continuously defy prediction there would be no risk, and without risk there would be no speculation, and without speculation there would be no liquidity, and without liquidity there would be no markets. The reason markets work as an effective means of raising capital is precisely because they are so unpredictable, which invites speculation, which invites liquidity. Anyone who believes that he or she can predict an outcome by watching virtual markets like NewsFutures and the Hollywood Stock Exchange does not understand markets. One prediction that appears guaranteed, however, is that people who invest in a company that bases its revenues on predicting outcomes by predicting markets will lose their money.
Max Kieser, Villefranche-sur-Mer, France.
KARMABANQUE — CONSUMER STOCK BOYCOTTS
Consider a May 9, 2004 article by Simon Romero in The New York Times, “War and Abuse Do Little to Harm U.S. Brands.” Romero begins: “When American troops moved into Iraq last year, European executives at the Ford Motor Company braced for an adverse consumer reaction.” Niel Golightly, a Ford spokesman in Cologne, Germany added: “Our sales and image and market share are things we monitor extremely closely. So the potential fallout risk from Ford being perceived as a symbol of America’s foreign policy is something we’re always looking at.” Romero goes on to claim that U.S. corporations have thus far remained relatively unscathed by the rampant anti-American feelings across the globe. “McDonald’s, one of the largest private-sector employers in Brazil, is sometimes the target of taunts in left-wing demonstrations on Avenida Paulista, one of Sâo Paulo’s main streets, but it is also common to see demonstrators eating at McDonald’s after the rallies,” he explains. “For the most part, boycotts announced against American products last year have fizzled out.”
An example of this took place just before the U.S. invaded Iraq in March 2003. “The Muslim Consumer Association of Malaysia called for a boycott of Coca-Cola,” writes Romero, “and there was a flurry of news media reports on the sudden popularity of local brands of cola.” According to Marimuthu Nadason, secretary general of the Federation of Malaysian Consumers Associations, that boycott was essentially ignored. “Anyone can call for a boycott,” Nadason said, “but it won’t work.” Not so, says Max Keiser, founder of Karmabanque (http://www.karmabanque.com), where “the civil disobedience of Gandhi” is combined with “the financial savvy of George Soros.”
“You don’t need guns or money to destroy American companies-and the environmental catastrophes they thrive on,” Keiser declares. “All we ask is that you focus your dissent on one company at a time and we ask that you focus that dissent/attention on a company that is vulnerable to the low cost weapon of choice for activists: the boycott.”
Keiser points to the recent “carbohydrate boycott”-and resulting plummet in the stock price-of Krispy Kreme donuts. “These companies are not able to defend against a boycott or organized dissent,” he says. According to Karmabanque’s Boycott Vulnerability Ratio-and contrary to unsuccessful efforts in Malaysia-Coca Cola is about as vulnerable to boycott as a corporation can get. “This means that for every dollar I do not spend on Coke, I am erasing 5 dollars off their market capitalization (number of shares outstanding times the current stock price),” says Keiser. The number, he explains, is devised by dividing market capitalization by trailing twelve-month sales.
The “magic,” says Keiser, occurs when “word gets out to the 800 billion dollar hedge fund industry-beholden to no one-that there is a very large boycott of Coke’s stock. A big boycott equals loss of revenues equals lower stock price. Mr. Hedge Fund sells short stock (a bet that the stock price will go down) in Coke. Sure enough, the stock price is going down. More boycotters, cost free to them, join the boycott and more hedge money goes into selling short the stock. Now, my $1 of dissent, multiplied times 5, is multiplied again thanks to the hedge money.
“Both hedge funds and activists benefit when a target company’s stock price declines,” says Keiser. “The hedge funds get dollars, while the activists get a new way to pressure companies by attacking their stock price. At some point, the stock price gets so low that the company cries ‘uncle’ and gives in to the pressure group is some way.”
CONTRARIAN ACTIVISM + LEARNING to THINK IRRATIONALLY
George Soros, irrationality and contrarian activism / by Max Keiser
The typical activist approach of trying to get rich countries and companies to ‘share the world’s resources’ fails to take into consideration how the individuals in these countries and companies got rich to begin with. What activists don’t understand is that the process of accumulating wealth is rarely a rational, direct path. Trying to appeal to the rich to act rationally, therefore is, in most cases, folly.
Activists need to get into the heads of the rich and understand that in order to create above-average wealth it is necessary for the rich to think in ways no average (read: poor) person is thinking. Financiers and speculators call this form of antagonism-for-profit ‘contrarianism’ and it forms the basis of an entire school of finance that attempts to figure out where the ‘crowd’ is heading, and then do the opposite. Some quick examples of how this works; 1) the put-call ratio in the options markets. What this number tells contrarians is where most of the speculators are making bets in the markets, and as most speculation ends up in losses it makes sense, according to the contrarian doctrine, to bet the other way. 2) Another contrarian speculating strategy is to look at where professional money managers are placing their bets with their professionally managed funds. Again, since most professional money managers fail to ‘beat the market,’ it makes sense to do the opposite of whatever they’re doing.
Probably the king of contrarianism is the most successful investor in the history of Wall Street: George Soros. He’s taken the contrarian concept and developed it even further into what he calls his theory of ‘reflexivity’ or the ‘human uncertainty principle.’
What Soros has observed about markets is that contrarianism itself can breed second and third generations of contrarianism that is self referential or ‘reflexive’ that, instead of doubling back and ending up where it started, has the power to change the underlying market fundamentals in ways that make the contrarian assumption the de factor market norm. When such situations develop, it’s only a matter of time before the market realizes it’s ‘smoking its own belly button lint’ (my expression) and we get what Soros calls, a ‘return to equilibrium’ i.e., a crash, like we saw in stocks in 1929, 1987 and 2000. For the professional trader, identifying these inflection points where the market suddenly realizes that its assumptions are worth zero, great fortunes can be made betting the other way. Soros caught the crash in the English pound back in 1992 using this technique and pocketed over 1 billion dollars in one day.
The point I’m making here for activists is that activists’ approach to changing the way business treats the environment relies almost entirely on trying to get business people to act more rationally. And yet, to get to where they got, these business leaders have relied mostly on obeying the voices in their head that the status quo claims are irrational. This has set up a paradox making NGO’s lives more difficult. Whatever an NGO thinks is a good idea, is probably a terrible way to make money in the minds of most businessmen. They’ll listen to what an NGO has to say, but only to know what not to do if they want to continue making money. It’s like what Milton Friedman advises corporations to do when an NGO walks into their office with a list of demands, and I paraphrase; ‘listen politely, then figure out if there’s any money to be made with what’s been said, if not, use the meeting as a PR opportunity, but that’s all.’
So does this mean NGO’s should give up? No. What it does mean, however, is that NGO’s should consider adopting new strategies that will tap into businessmen’s love of the irrational. For environmentalists, I think carbon trading offers a huge opportunity to turn the tables on business and use the power of irrationality for a positive change.
Take a group like Greenpeace for example. They have over 100 million dollars sitting in the bank collecting money market interest. For all intents and purposes, this money is what Wall Street would call, ‘dead money.’ I propose the following. Greenpeace should start organizing a banking crusade with their money and other NGO money (NGO’s combined operating budgets are worth 1 trillion dollars) and start buying Carbon Credits in the open market for the current price of approximately 8 dollars a ton. (the EU has started a program of capping carbon emissions for corporations; but giving them the opportunity to go over their cap by buying ‘credits’ from companies whose carbon output is below the cap).
This would set up an irrational chain reaction, each part of which represents a net positive for the environment. First, the price of carbon credits will be pressured upward thanks to the speculative buying of a new force in the market, NGO’s. Corporations who are banking on the price of carbon credits to remain in a certain range will be forced to recalculate their assumptions and in many cases will be forced to buy more credits than they had planned to in the short term to give themselves the kind of hedging protection these carbon credits offer for their carbon abuse. This will drive the price even higher. As demand goes up, so does the price and now we get to the irrational part; higher carbon prices will incentivize companies across the business spectrum to put forward various carbon-efficiency schemes as a way to make money with their excess credits. The money a company makes chasing carbon efficiencies could equal if not eclipse the profits made burning carbon. The government in turn, has the ability to lower the carbon caps greasing this contrarian cycle even more by making carbon more expensive, thus providing more incentive to produce greater efficiencies.
On paper, activists will look at this and balk. They don’t like the idea of commoditizing nature. They don’t understand why a company would engage in such a scheme. They don’t like the fact that the whole thing seems irrational, but that’s the point. Business today runs on irrationality and until NGO’s adapt, they’ll always be behind the curve. You would think NGO’s would have already figured this out. They know for example that ExxonMobil’s business model is irrational to the bone. ExxonMobil extract irreplaceable natural resources for virtually nothing, sell them for a fraction of their replacement costs and then we burn them without ever having to pay the environmental costs; all this resulting in parts of CO2 per million in the atmosphere breaching the ‘can’t go back’ levels where the species (ours) is put on the extinction watch list. ExxonMobil’s business model is irrational and suicidal. NGO’s know this, so why do they insist in trying to get Exxon to act rationally when nothing in Exxon corporate DNA suggests they even understand what that word means.
Exxon is not rational, but they are profitable. For NGO’s to attack their rationale is a non-starter because the company knows it’s irrational and doesn’t care. Environmentalists, to win against this insanity, must tear a page out of the irrational’s handbook in order to effectively combat the current trends blighting our futures. The carbon trading scheme mentioned above is a step in that direction. As distasteful as it must seem for NGO’s to drink the ‘Koolaide’ that runs business, not to do so at this point is completely irrational.
TULIPS, for the GENERALIST
PROPOSAL: DECENTRALIZE MONETARY POLICY
How to Decentralize Monetary Policy / July 21, 2006
Today’s Wall Street Journal reports: “Federal Reserve policy makers raised interest rates last month in part because markets expected them to do so, and they figured failure to act might hurt their credibility as inflation fighters, minutes of the meeting suggest.”
Some people might view this response as wimpy–doing what financial markets want rather than showing real leadership. But one can view this approach as a step toward decentralizing monetary decision making. Suppose the Fed has a long-term inflation target. And suppose the Fed followed this rule: “Look at the market’s forecast of interest rates and inflation over the next few years. If the market expects inflation above target, set a path for interest rates a bit higher than the market expects. If the market expects inflation below target, set a path for interest rates a bit lower than the market expects. If the market expects inflation to come in on target, set a path for interest rates equal to what the market expects.”
This might seem circular: The Fed is responding to the market, and the market is responding to the Fed. But there is nothing wrong with that. Economists are used to simultaneity. Of course, the market will catch on to the policy, but that’s okay. In fact, it is ideal. We end up in a fixed-point equilibrium in which the market expects the Fed will hit its inflation target. In this equilibrium, the market’s forecast of interest rates will tell the Fed what it needs to do to accomplish what it wants to accomplish.
ORGANIZING WITHOUT ORGANIZATIONS
What’s the connection between a 1906 poultry exhibition and the 2008 US election?
by Leighton Vaughan Williams / 18 September 2008
Sir Francis Galton was an English explorer, anthropologist, scientist, who was born in 1822 and died in 1911. To students of prediction markets he is best known, however, for his visit, at the age of 85, to the West of England Fat Stock and Poultry Exhibition, and what happened when he came across a competition in which visitors could, for sixpence, guess the weight of an ox.
Those who guessed closest would receive prizes. About 800 people entered. Ever the scientist, he decided to examine the ledger of entries to see how clever these ordinary folk actually were in estimating the correct weight. In letters to ‘Nature’ magazine, published in March of 1907, he explained just how ordinary those entering the competition were. “Many non-experts competed”, he wrote, “like those clerks and others who have no knowledge of horses, but who bet on races, guided by newspapers, friends, and their own fancies … The average was probably as well fitted for making a just estimate of the dressed weight of the ox as an average voter is of judging the merits of most political issues”.
The results surprised him. For what he found was that the crowd had guessed (taking the mean, i.e. adding up the guesses and dividing by the number of entrants) that the ox would weigh 1,197 pounds. In fact, it weighed 1,198 pounds! The median estimate (listing the guesses from the highest to the lowest and taking the mid-point) was also close (1,207 pounds, and therefore still within 1% of the correct weight) but not as close. Some have argued that Galton himself favoured the use of the median rather than the mean, and so was double-surprised when the mean beat the median. Others have argued that the point is incidental and what this tale demonstrates about the wisdom of the crowd is more important than such a fine statistical detail.
I think that both these points of view contain some merit. The power of the market to aggregate information is indeed a critically important idea. But it is also important to be able to distinguish in different contexts which measure of the ‘average’ (the mean, the median, or perhaps some other measure) is more suited to the purpose at hand.
Take the stream of opinion polls which contribute to the collective knowledge that drives the Betfair market about the identity of the next President of the United States. If five are released, say, on a given day, what is the most appropriate way of gauging the information contained in them? Should we simply add up the polling numbers for each candidate and divide by the number of polls, or should we list them from highest polling score to lowest and take the mid-point. The convention adopted by sites such as www.realclearpolitics.com is to take the mean. But is there a better measure than the mean of discerning the collective wisdom contained in the polls, and if so, what is it? The jury is still deliberating.
Leighton Vaughan Williams
email : leighton.vaughan-williams [at] ntu.ac [dot] uk
COLLECTIVE BEST GUESS CORRECT WITHIN a FURLONG
“Question: How do you find a missing submarine? Answer: Ask the audience”
by Leighton Vaughan Williams / 8 April 2008
During a car journey between Nottingham and Warwick the other week I was told a story about the value of crowd wisdom in turning up buried treasure. The story was that by asking a host of people, each with a little knowledge of ships, sailing and the sea, where a vessel is likely to have sunk in years gone by, it is possible with astonishing accuracy to pinpoint the wreck and the bounty within. Individually, each of those contributing a guess as to the location is limited to their special knowledge, whether of winds or tides or surf or sailors, but the idea is that together their combined wisdom (arrived at by averaging their guesses) could pinpoint the treasure more accurately than a range of other predictive tools. At least that’s the way it was told to me by an economist who was in turn told the story by a physicist friend.
To any advocate of the power of prediction markets, this certainly sounds plausible, so I decided to investigate further. Soon I was getting acquainted with the fascinating tale of the submarine USS Scorpion, as related by Mark Rubinstein, Professor of Applied
Investment Analysis at the University of California at Berkeley. In a fascinating paper titled, ‘Rational Markets? Yes or No? The Affirmative Case’, he tells of a story related in a book called ‘Blind Man’s Bluff: The Untold Story of American Submarine Espionage’ by Sherry Sontag and Christopher Drew.
The book tells how on the afternoon of May 27, 1968, the submarine USS Scorpion was declared missing with all 99 men aboard. It was known that she must be lost at some point below the surface of the Atlantic Ocean within a circle 20 miles wide. This information was of some help, of course, but not enough to determine even five months later where she could actually be found.
The Navy had all but given up hope of finding the submarine when John Craven, who was their top deep-water scientist, came up with a plan which pre-dated the explosion of interest in prediction markets by decades. He simply turned to a group of submarine and salvage experts and asked them to bet on the probabilities of what could have happened. Taking an average of their responses, he was able to identify the location of the missing vessel to within a furlong (220 yards) of its actual location. The sub was found.
Sontag and Drew also relate the story of how the Navy located a live hydrogen bomb lost by the Air Force, albeit without reference in that case to the wisdom of crowds. Perhaps, though, that tale is too secret yet to be told!
What then, I wonder, would those scientific giants, Karl Pearson and Lord Rayleigh, have made of it all? It was their correspondence, you may recall, in the pages of the scientific journal, ‘Nature’, which answered the classic query of where to find the drunk you left in a field. “Where you left him,” was the answer. Which is all very well, of course, if you were sober enough yourself to know exactly where that might have been!
Information Successes of Speculative Markets / BY Robin D. Hanson
While democratic policy seems to suffer from information failures, speculative markets show striking information successes. Most markets for stocks, bonds, currency, and commodities futures are called speculative markets because they allow people to bet on future prices by buying or selling today in the hope of reversing such trades later for a profit. Such opportunities to “buy low, sell high” occur when identical durable items are frequently traded in a market with low transaction costs. Given such opportunities, everyone is in essence invited to be paid to correct the current market price, by pushing that price closer to the future price. Such invitations are accepted by those sure enough of their beliefs to “put their money where their mouth is,” and wise enough not to have lost too much money in previous bets. Betting markets are speculative markets that trade assets that are specifically designed to allow people to bet on particular matters of fact, such as which horse will win a race. The final values of such assets are defined in terms of some official final judgment about the fact in question. By construction, such assets are durable, identical, and can be created in unlimited supply. Betting and other speculative markets have been around for many centuries, and for many decades economists have studied the ability of such markets to aggregate information. The main finding of this research is that such markets tend to be relatively “efficient” in the sense that it is hard to find information that has not been incorporated into market prices (Lo, 1997; Hausch, Lo, & Ziemba, 1994). The main possible exceptions seem to be long-term aggregate price movements, and a long-shot bias in high-transaction-cost betting markets.
Many have suggested that asset markets have too much long-term aggregate price variation, such as stock market “bubbles” (Shiller, 2000). Risk and delay most discourage speculators from correcting such pricing errors, and irrational traders can actually gain superior returns (though not utility) from irrationally-large risk-taking (De Long, Shleifer, Summers, & Waldmann, 1990). Long-term aggregate prices, however, are also where it is hardest to empirically distinguish irrationality from rational information about fundamental economic change (Barsky & De Long, 1993), and where selection effects most pollute our data (Jorion & Goetzmann, 2000). Even if speculative markets are distorted by irrational bubbles, it is not clear that any of our other information institutions do better. For example, no other information institution in our society, such as academia or news media, consistently predicted that we were over-investing during the “dotcom” bubble. Yes some individual academics or reporters so predicted, but so did some individual stock investors. Over the last few decades economists have also studied speculative markets in laboratory experiments, where they have more control over trader information and preferences. Such experiments find that speculative markets aggregate information well, even with four traders trading $4 over four minutes, and even when such traders know little about their environment or other traders (Sunder, 1995). For example, traders can aggregate information well when they are experienced in their role and abstractly know the payoffs of players in other roles (Forsythe & Lundholm, 1990). If the structure of traders’ information is complex enough relative to the number of assets available to trade, however, information “traps” can occur where individual traders have no direct incentive to reveal their information (Noeth, Camerer, Plott, & Webber, 1999). Such problems are typically, though not always, reduced by allowing trading of more kinds of related assets.
Absolute accuracy levels, however, are not the key issue. The key policy question about any institution is how it performs relative to alternative institutions dealing with the same situation. A few studies have presented field data on this question, directly comparing real world speculative markets with other real world institutions for aggregating information. For example, racetrack market odds improve on the prediction of racetrack experts (Figlewski, 1979). Florida orange juice commodity futures improve on government weather forecasts (Roll, 1984), Oscar markets beat columnist forecasts (Pennock, Giles, & Nielsen, 2001), and gas demand markets beat gas demand experts (Spencer, 2004). Betting markets beat major national opinion polls 451 out of 596 times in predicting U.S. presidential election results (Berg & Rietz, 2002). Finally, betting markets beat Hewlett Packard official forecasts 6 times out of 8 at predicting Hewlett Packard printer sales (Chen & Plott, 2002; Plott, 2000). Unfortunately, no studies have directly compared estimates from speculative markets to estimates from academic-style institutions We do know, however, that those who do best at betting on horse races are smart in ways they can not articulate, and in ways unrelated to I.Q. (Ceci & Liker, 1986). Academic-style institutions, in contrast, seem largely limited to aggregating articulated knowledge from those with high I.Q. Academic institutions put a great deal of weight on the opinions of experts relative to ordinary people. And while speculative markets may put less weight on experts, it does not seem that they place too little; if anything, they seem to put too much weight on experts, both public and private (Figlewski, 1979; Metzger, 1985; Lichtenstein, Kaufmann, & Bhagat, 1999). How can betting markets beat opinion polls when they use the same fallible human sources?
A study of election betting markets found that traders overall suffered from standard biases such as expecting their favored candidate to win, and seeing that candidate as having won debates. “Market makers,” however, were found to be on average much less biased. These were traders who made offers that others accepted, rather than accepting offers made by others. Compared to other traders, market makers invested twice as much, traded more, earned higher returns, and made one sixth as many errors. They also tended to be more highly educated, and experienced at trading (Forsythe, Nelson, Neumann, & Wright, 1992; Forsythe, Rietz, & Ross, 1999). Betting markets seem to meet or beat competing institutions in part because of the disproportionate influence such markets give to rational and informed traders. We also know more generally that people with stronger incentives to be accurate show fewer cognitive biases (Kruglanski & Freund, 1983). There are costs to create and run markets, so there is a limit to the number of markets that can be created. However, while it was once thought that speculative markets could only be viable if they annually traded millions of dollars, say 10,000 trades of $100 each (Carlton, 1984), it is now clear that much smaller markets are viable. For example, laboratory experiments consistently show the viability of very small markets. Low internet transaction costs are also now spurring a burst of innovation exploring a great many new market forms (Varian, 1998; Shiller, 1993; Hanson, 2003a). Play money web markets are now available where anyone can create new betting topics, and where a handful of traders betting play pennies once every few weeks are typically successful at aggregating information into prices (see, for example, hsx.com, ideosphere.com (Kittlitz, 1999; Pennock et al., 2001)).
Gambling and securities regulations make it very difficult, however, to create real money markets like these play money markets. This regulatory block on financial innovation should not be surprising, because all of our familiar financial institutions were once prohibited by laws against gambling and usury. For example, a thirteenth century decree by Pope Gregory IX prohibited maritime insurance as usury. The 1570 Code of the Low Countries outlawed life insurance as gambling (Brenner & Brenner, 1990). In response to speculation in the South Sea Bubble, in 1720 Britain basically banned the formation of joint-stock companies (Kindleberger, 1984). And futures markets were banned as gambling in the late nineteenth century U.S. (Brenner & Brenner, 1990). The history of financial regulation can thus be roughly summarized as everything being banned as gambling (or usury) until an exception was granted for some newly legitimized higher purpose. For each purpose, such as capitalizing firms, insuring idiosyncratic risk, or insuring common risk, laws and regulations were created to ensure that generic gambling could not slip in. We may thus reasonably hope to someday legitimate, and thereby legalize, markets whose main function is to aggregate information on questions that matter (Bell, 1997).
Ayn Rand Saw This Coming / October 9, 2008
“Despite overwhelming evidence that government policies caused the current financial crisis, Congress is blaming businessmen,” said Yaron Brook, executive director of the Ayn Rand Center for Individual Rights. “What’s worse, the capitalists who have been shackled with unprecedented regulatory burdens are unable to defend themselves
morally. Though the events are different, this pattern of abuse and submission is straight out of Ayn Rand’s Atlas Shrugged. “The cycle starts with government intervening into the economy and imposing regulations and controls on business. This distorts the free market, leading to economic dislocations. When the problems caused by these distortions inevitably follow, everyone blames the free market and its greedy capitalists. The proposed solution? More government controls. Over the years, conservative critics of creeping government have repeatedly exposed this illogic but have always been helpless to explain why the cycle keeps repeating, decade after decade. “The pattern keeps recurring because businessmen are willing to take the blame. From capitalism’s inception, its defenders have been morally disarmed by the widespread view that self-interest is morally suspect, and disinterested service to others is a moral ideal. So each new spate of controls has been grudgingly accepted as a fair price to pay for society’s toleration of the selfish pursuit of profit. “Atlas Shrugged depicted a society in economic collapse due to this recurring cycle, and today’s parallels are obvious. Government manipulation of money, credit, and lending standards over several decades caused the mess we’re in. Now, the offered solution is more of the poison that sickened the economy–more bailouts, more cheap money, more government-guaranteed loans, and above all, more regulations. “This chronic cycle will not end until businessmen accept that their production of profit is neither immoral nor amoral–it is the capstone of moral virtue. Once they shrug off the role of scapegoat, businessmen can demand with moral certitude that government punish fraud and enforce contracts but refrain from interfering with voluntary trades among consenting adults. “When America’s markets are finally free of all coercion–in other words, when laissez-faire is achieved–financial crises such as the one we’re experiencing will never happen again.”
AYN RAND INSTITUTE: ‘GREENSPAN SOLD OUT’
Greenspan Has No Free Market Philosophy / October 24, 2008
“Opponents of the free market are giddy at Alan Greenspan’s declaration that the financial crisis has exposed a “flaw” in his “free market ideology.” Greenspan says he is “in a state of shocked disbelief” because he “looked to the self-interest of lending institutions to protect shareholder’s equity”–and it didn’t. But according to Dr. Yaron Brook, executive director of the Ayn Rand Center for Individual Rights, “any belief Greenspan ever had in truly free markets was abandoned long ago. While Greenspan long ago wrote in favor of a truly free market in banking, including the gold standard that such markets always adopt, he then proceeded to work for two decades as leader and chief advocate of the Federal Reserve, which continually inflates the money supply and manipulates interest rates. Advocates of free banking understand that when the government inflates the currency, it artificially increases prices and causes booms in certain sectors of the economy, followed by inevitable busts. But not only did Greenspan lead the inflation behind the dot-com bubble and the real estate boom, he blamed the market for their treacherous collapses. Greenspan should have recognized that what he wrote in 1966 of the boom preceding the 1929 crash applied here: ‘The excess credit which the Fed pumped into the economy spilled over into the stock market – triggering a fantastic speculative boom.’ Instead, he superficially blamed ‘infectious greed.’ “Should it be any shock that Greenspan now blames the free market for today’s meltdown – rather than the Fed’s policies, which fueled an inflationary housing boom, which rewarded reckless lenders and borrowers from Wall Street to Main Street? Greenspan didn’t mention the word ‘inflation’ once in his testimony. “Whatever Greenspan’s economic philosophy is, it is not anything resembling a free market.””
ENLIGHTENMENT HARD to REGULATE
Greenspan Shrugged? Did Ayn Rand Cause Our Financial Crisis?
“Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself especially, are in a state of shocked disbelief.” So said former Fed Chairman Alan Greenspan in his dramatic testimony before the House Committee on Oversight and Government Reform, as he was grilled by committee members on the causes of the nation’s financial crisis. Greenspan, whose laissez-faire capitalist leanings led him to reject decades of calls for more robust government oversight of financial markets, was repeatedly interrupted by the lawmakers in a contentious exchange that clearly shows the gloves are off in regard to the former chairman’s legacy. In his startling admission, the former head of the Federal Reserve reveals that his long-held and controversial notion that enlightened self-interest alone would prevent bankers, mortgage brokers, investment bankers and others from gaming the system for their own personal financial benefit has, as the English say, come a cropper. Bankers ruled by anything other than greed?
Where did Greenspan ever get that idea? Ayn Rand. To readers of Atlas Shrugged, Ayn Rand’s 1957 magnum opus, Greenspan’s hands-off philosophy of marketplace management sounds very familiar. At its core, the book supports a radically utopian political-economic system called Objectivism, which suggests that the morality of rational self- interest, as opposed to religious or government intervention, should be the foundation of the ideal political structure. According to a short description of Objectivism given by Ayn Rand in 1962, “The ideal political-economic system is laissez-faire capitalism … In a system of full capitalism, there should be (but, historically, has not yet been) a complete separation of state and economics, in the same way and for the same reasons as the separation of state and church.” In other words, Ayn Rand’s theory of the “morality of self-interest” exactly parallels Alan Greenspan’s testimony today about his now-shaken belief in the ability of “self-interest of lending institutions to protect shareholder’s equity.”
Early in his career, Alan was an avid Rand acolyte, a frequent guest at the Manhattan salon of the novelist and philosopher, and those who gathered to hear the litanies of like-minded notables were loosely known as “The Collective.” It was there that the Rand philosophy of Objectivism was discussed in the context of current events, world markets and religion. Today, 40 years after the heyday of those gatherings, Greenspan surprised many with his “Yes, I found a flaw” response to a grilling from the Committee. Responding to the clear failure of the notion of “enlightened self-interest” to stop the cascade of financial catastrophies that have roiled world markets, he said, “That is precisely the reason I was shocked, because I’d been going for 40 years or more with very considerable evidence that it was working exceptionally well.”
Greenspan’s critics have long charged that his refusal as Fed Chairman to impose greater government regulations on mortgage lenders is one of the causes of the sub-prime mortgage meltdown. Committee Chairman Harry Waxman (D-CA), in a heated exchange told the former Fed Chairman that he had “the authority to prevent irresponsible lending practices that led to the subprime mortgage crisis. You were advised to do so by many others, and now our whole economy is paying the price.”
“This always astounds me. Even when writers claim to be very well acquainted with Rand’s work, they miss the most obvious intellectual contradiction of Geenspan’s entire career with the Fed. Ayn Rand considered The Federal Reserve one of the greatest abominations ever created. She had no problem with the concept of a Central Bank created by the banks to facilitate that private industry. But to give that entity manipulative control over the American monetary system was anathema. A TREMENDOUS threat to her laissez faire capitalism. To her, a horrific concept made worse by its fragmentation from any direct connection to the democratic Republic process. This stuff is Ayn Rand 101. And Greenspan would become a major influence and Chair it for 18 years? Greenspan never got his PhD. He would be granted it in 1977 without thesis or dissertation. That is not in any way to cast dispersions on his qualifications. It is to note that he was Ayn Rand’s #1 economic student / representative. It was their discussions, from which Greenspan concluded that the schooling was not in line with his thinking and a waste of time. That’s how close they were. To this day, Greenspan has never publicly resolved the intellectual contradiction of his job at The Fed, with the teachings of Ayn Rand. The gnarliest supposition being he believed only he could prevent this innate monster from doing its evil. That’s sad.”
CHECK YOUR PREMISES
WHO is JOHN GALT?
a NATION of INDIVIDUALS
Ayn Rand’s Normative Ethics: the Virtuous Egoist
by Tara Smith / Reviewed by Helen Cullyer
Those who think of Ayn Rand as the icon of callow youths rather than a serious moral philosopher are unlikely to recognize the Rand whom Smith presents to us. Drawing on Rand’s novels, lectures, essays, and letters, Smith shows that her ethical theory is a form of naturalistic eudaimonism, which shares some features with the Aristotelian virtue ethics of Hursthouse and Foot, but differs from them in its unapologetic ethical egoism. This egoism is, however, as Smith argues, non-predatory and can accommodate helping others, genuine friendship, and even in certain circumstances risking one’s life for another. Ultimately Rand appears as a somewhat paradoxical figure. A veneer of Nietzschean immoralism conceals the fact that, according to Smith, serving one’s own interest in Randian fashion entails treating others in ways that are not as out of line with standard moral thinking as we may first assume. After tracing the outlines of Smith’s argument, I will a raise worry as to whether her insistence that the virtuous agent places non-instrumental value on a variety of social relationships actually undermines Rand’s egoistic individualism, and discuss briefly the political implications of Rand’s ethics that hover just beneath the surface of the book.
In her Introduction, Smith argues that contemporary virtue ethicists dance around the question of ethical egoism. The reason is that egoism is usually considered predatory, hedonistic, or subjectivist. Chapters 2 and 3 provide a rigorous discussion of the Aristotelian grounding of Rand’s project. Humans, just like animals or plants, have certain objective ends (food, water, safety) that promote our lives, but humans’ ultimate goal is not only to maintain our lives, but to live well, which means excellent functioning, both physical and psychological (32). Such functioning is manifest primarily, as we learn in Chapter 8, as the active exercise of the virtue of productiveness, when we transform our natural surroundings in ways that meet our material and spiritual needs. Since excellent functioning is the goal of human life, reasons for acting must be egoistic; a person can only achieve this goal through her own efforts (33). Egoistic rational principles “stem entirely from their practical service to self-interest, as that is judged by rational, long-range standards” (36), and genuine self-interest cannot truly conflict with the interest of others (39). To be rational is to recognize and accept “reason as one’s only source of knowledge. . . It means one’s total commitment to a state of full consciousness awareness, to the maintenance of a full mental focus” (52). The human capacity for reason is grounded metaphysically in free will, but to reason well is to realize the inescapability of general facts about human nature and also the context-dependent facts of particular situations.
Chapters 4-9 concern the other six virtues (honesty, independence, justice, integrity, productiveness and pride), which are forms or aspects of rationality, the “master” virtue (49). Smith’s discussion of the six is searching and often compelling. In fact, even those who do not think that egoism is a viable moral theory will recognize the importance of many of these virtues for the virtuous life. Pride turns out to be self-respect plus the desire for self-improvement. Integrity is strength not only in holding onto one’s ideals, but also in making them practical reality. The egoistic defense of honesty is also intriguing: pretense is “metaphysically impotent” in that in misrepresenting reality we cannot change it (79). Moreover, dishonesty is detrimental to self-esteem and fosters a sense of worthlessness.
Most controversial is the egoistic defense of justice. Smith argues, following Rand, that it is in one’s own interests to treat people in accordance with objective desert. This view entails a rejection of egalitarianism, and Smith sets the Randian conception of justice squarely in opposition to that of Rawls. But the Randian view is tempered by three qualifications: (1) desert is contextual, and one must distinguish between those things over which people do and do not have control; (2) justice coexists with rights, since “each individual has a right to his own life and to pursue his own happiness” (171); and (3) the virtuous egoist will refuse to sanction evil.
In Chapter 10 and the Appendix, Smith moves away from Rand’s “official” seven virtues and discusses implications for charity, generosity and temperance, and for loving others. Although the virtuous egoist will often have no reason to act generously or charitably, Smith gives examples of many situations where the virtuous egoist will act in these ways for the sake of some benefit to herself. In an Appendix, Smith, employing arguments that bear some similarity to those of Aristotle in Nicomachean Ethics 9.8, argues that the virtuous agent can in fact love others for their own sake, although her own happiness remains her ultimate goal.
Before raising an objection to Smith and Rand, it is worth noting briefly how they differ from other philosophers in the eudaimonistic tradition, who tend to view the good of the individual as both social and political. Most Aristotelians think that character is formed in a social and political context, and that human flourishing cannot be understood without considering individuals as parts of a community; as a result of ethical habituation, but also of natural sociality, we have reason to promote others’ good. Thus Foot argues that humans are just particularly complex social animals, and she does not take the agent-centeredness of her ethical theory to entail that all of the virtuous agent’s reasons for acting are egoistic.  Aristotle himself asserts that the virtuous agent undertakes fine actions for the sake of the fine (to kalon). While this motivation is not altruistic, fine actions are just those that are contextually appropriate for a socially and politically embedded individual. For Rand on the other hand, the moral self, while existing in a community, is free of it, self-created, and materially and psychologically independent; humans are not by nature “social” but they are “contractual” (130). Smith endorses not only Rand’s principle that it is never moral to put another’s good above one’s own but also asserts that “ethics is not essentially social” (284).
Smith works hard, however, to show that the virtuous egoist’s relationships with other people will be rich and rewarding. The egoist may even risk her life for another. Consider this example. A man, Bill, risks his life for the woman he loves, because “for him to courageously attempt the rescue and not “chicken out” would be in his interest (assuming that he values the woman’s well-being more valuable than his life without her)” (194). According to egoism one should not sacrifice oneself for another (38), but the egoistic defense of the action is that this woman is one of the things that makes Bill’s life worth living. Bill is making no sacrifice, but rationally placing her well-being, which he sees as central to his own happiness, above his own safety. We should note that Smith makes clear in her Appendix that the virtuous egoist can love others for their own sake, and not instrumentally, precisely because “another person might become valuable by becoming a vital ingredient of a person’s happiness” (302). But if one’s own flourishing includes the welfare of others, then we might object that human flourishing is after all a social rather than individualistic enterprise. For Bill realizes that his happiness involves loving others and risking himself for them. Smith will reply that the above example is unusual, and should not be taken as evidence that morality is somehow social. This kind of love is the exception and not the norm. It is only moral to put oneself in harm’s way for another when two self-created, independent, and rational individuals love each other as friends. Most people will not merit this treatment. For one must exercise one’s own independent judgment to figure out who is truly valuable to oneself (130-32).
But in fact Smith recognizes so many social relationships which enhance the flourishing of the individual (258-61), and which are based on affection, respect, and shared activity, that the careful reader may wonder whether Rand’s view that man is a “contractual” animal, rather than a “lone wolf” or a “social animal” (130) can any longer be sustained. Smith begins to address this worry by noting that although generosity is only rational when it represents a fair trade of one value for another, the return that the benefactor receives in compensation for his service is not necessarily material: “the return can take many forms — intellectual, emotional, the pleasure of a person’s company, the deepening of a relationship” (261). One might agree with Smith here that if I give away a football ticket to an acquaintance, I am certainly acting in a way that shows that the value I place on the relationship is greater than the value I place on the ticket. I gain from the act of generosity by deepening our friendship, and ‘trade’ the ticket for something better. But the act of generosity is not truly a trade with my acquaintance unless I give the ticket to her with an expectation of receiving a determinate quantifiable and commensurable benefit in direct return. If I trade a football ticket for the deepening of a friendship, has ‘trade’ here not become a mere metaphor? The pleasure of company and the deepening of relationships are surely benefits to be shared and enjoyed communally, not traded? If this is the case, then individual human flourishing may turn out to be activity of the individual who is fully immersed in shared activities and purposes, rather than the rational trading of benefits between contractual individuals. The virtuous agent may still be an egoist formally speaking, in that she realizes that what is really in her interest is to engage in shared activities and purposes. But the ‘I’ tends to become a ‘we’, and the other and self united in a relationship that promotes our happiness.
Smith’s discussion of independence (129-30) suggests that one important aspect of the claim that humans are not social is that the ethical-intellectual formation of the individual is not dependent on society. But if social activity is somehow central to the life of a rational adult, as Rand and Smith admit, might we not object that such activity is also central to the life of an incipiently rational child and that it is precisely this social context of human development that shapes the self? Smith dismisses the idea that individuals’ characters and actions are determined by the society in which they are raised as empirically indefensible (129), but there is a more subtle and convincing position that Smith should address; namely that we are necessarily influenced, although not determined, by the societies in which we are raised and that moral and practical reasoning capacities grow not spontaneously, but out of and in reaction to specific communities.
Perhaps, however, we can best understand Rand’s and Smith’s position by putting it into its proper political context. The real claim being made here is not that humans do not tend towards sociality, but rather that by nature we are not part of a mutually sustaining political community or society in which individuals depend on each other. We must respect others’ rights, but we have no reason to help others whom we do not know and value personally, although we will trade goods with many for our own benefit. While altruism is placing others above the self as a “fundamental rule of life”, egoism does not entail sacrificing others for the sake of oneself, because the true egoist recognizes an objective and impartial right of everyone to pursue their own interest (39).
The coexistence of rights (to life, liberty, and property) and egoism is crucial to Rand’s ethics and politics. Smith does not try to argue here that recognizing and respecting the rights of others is directly or indirectly in one’s self-interest (174-5). In fact, the grounding of individual rights that she delineates looks rather Kantian: “Every living human being is an end in himself, not the means to the ends of the welfare of others. . . ” (171). The respecting of others’ rights, therefore, looks like it is a constraint on and exception to the egoistic ethical norm; act in self-interest except when it would infringe the rights of others. Yet Rand’s theory of rights and ethical egoism rest on the same teleological basis; since the goal of each individual is to maintain her life and to flourish, each individual requires freedom from the predatory actions of others.
Rand’s egoistic individualism supports her libertarian political outlook, and this is certainly not concealed in Smith’s treatment, although it is not in the foreground. Rand’s view of the virtuous egoist as self-created, contractual, and productive provides the ethical basis of her political ideal of unregulated laissez-faire capitalism in which government’s only role is to protect basic liberty and property rights. We should note that Rand’s libertarianism is consistent in some respects with social liberalism, having no truck with discrimination on the basis of sex, race, or sexual orientation, and supporting freedom of speech in all contexts. But if we ask why the virtuous egoist should not be a social democrat, voting for higher taxes in order to ensure not only freedom from predation, but basic opportunities (like healthcare, education, social insurance) which benefit not only others but also herself, the Randian will reply that such taxes would violate property and liberty rights, and true justice. The social democrat’s reply may argue for expanded conceptions of rights and freedom. But it will also surely attack as far too stringent Rand’s assumption that virtue requires that each of us is able to be materially independent, providing for the self “all the material values that his life requires” (202), and stress that the libertarian ignores the increased opportunity and power that individuals enjoy when they act in common. It is not to be taken as a criticism of Smith’s book that she does not engage more fully with these issues, given the ethical rather than political focus of the book. In fact, her 1995 book (see n. 2) does engage with some of these issues, although not from an explicitly Randian perspective. I raise the issue of Rand’s politics only to point out that her ethics and politics are intertwined.
It should be stressed in conclusion that whether one is a fan or a detractor of Ayn Rand, the issues raised by this book are manifold and provocative. This book should force a debate of renewed vigor about what we mean by egoism, whether and how the egoism / altruism dichotomy should be applied within eudaimonistic ethical theories, and what our ethical theories imply about our political outlook. Smith provides us with a version of egoism that will need to be argued against by those who find it distasteful or misguided, rather than simply dismissed.
NATHANIEL BRANDEN’S POST-MORTEM
The Benefits and Hazards of the Philosophy of Ayn Rand
A Personal Statement by Nathaniel Branden / May 25, 1982
MILTON FRIEDMAN on ECONOMICS of WAR on TERROR
CROWD-SOURCING the FUTURE
MECHANISM DESIGN THEORY