What's Ahead for Prediction Markets?

Is the outcome of a presidential election a commodity? How about the likelihood that an air strike will be made on Iran before the year is out? Or this: the chances that scientists will observe the illusive Higgs Boson particle before December 31, 2010?

Yes, yes, and yes. They’re all commodities in the sense that answers to those questions are traded as “event contracts,” and are part of a phenomenon known as “prediction markets” or “information markets.” Type intrade.com into your Web browser and you’ll land at a site where you can buy and sell contracts on everything from when Osama Bin Laden will be captured or “neutralized” to when mad cow disease will be detected in the U.S.

Closer to home, Richfield-based Best Buy has garnered attention lately (see the Wall Street Journal’s September 16 article) for its use of a prediction market to guide management decisions. With its TagTrade market, Best Buy looks at employee trades of imaginary stock on questions of whether a product rollout will happen on schedule or whether a sales forecast will be accurate. If front-line workers aren’t bullish on goals being met, the company investigates why, and tweaks its plans until the stock goes up.

Results during TagTrade’s first three years have bolstered Best Buy’s confidence in the “wisdom of crowds,” which is an underlying principle of all prediction markets. But while Best Buy’s employees trade make-believe dollars and look at questions of internal interest to the company, investors at Intrade and similar sites are using real money and placing bets on questions that can have larger commercial or economic impacts.

Not surprising, then, that the Commodities Futures Trading Commission (CFTC) was gathering public comments this summer on some questions of its own: Should event contracts—which have properties of both options and futures contracts—be regulated by the CFTC? And if so, how so? By limiting their trade to designated commodity markets? By establishing a new type of market? And to settle questions of jurisdiction, how will event contracts be distinguished from gaming, or from instruments and markets regulated by the Securities and Exchange Commission (which weighed in during the comment period to assert its authority)?