~ . -,. _,• .. 

Iowa 

University 

Electronic 

of Iowa 

Markets :dl ~ 

Tippie College of Business \) < 

W283 John Pappajohn Business Building ~~ & 

Iowa City, Iowa 52242-1994 - '\ (") 

319-335-0881 Fax: 319-335-1956 • .!1 

iem@uiowa.edu 

www.biz.uiowa.edu/iem O · 

::sO 

Office of the Secretariat 

Commodity Futures Trading Commission 

Three Lafayette Centre 

1155 21 st Street, NW 

Washington, DC 20581 

COMMENT ··vRe: Request for Public Comment on the CFTC's "Concept Release on the Appropriate 

Regulatory Treatment of Event Contracts" 

We, the undersigned, are members the Board of Directors for the Iowa Electronic 

Markets (I EM), which is the only event market to have received a No-Action Letter from 

the CFTC. We endorse the idea of the CFTC providing a "safe harbor" for small scale 

prediction markets in order to foster their development and provide needed research 

and innovation in information aggregation mechanisms. 

Our specific comments on parts of the Concept Release follow. 

1. What public interests are served by event contracts that are designed and will 

principally be traded for information aggregation purposes and not for 

commercial risk management or pricing purposes? 

The public interest that is served by Prediction Markets is primarily due to their role in 

information aggregation. The public interest is generally better served with more, rather 

than less, accurate information. The price discovery function of markets is as important 

in non-traditional markets, such as predicting outbreaks of avian influenza 1

, as it is in 

traditional markets such as orange juice futures. Improved knowledge about the 

likelihood of a particular event occurring allows decision makers greater latitude in 

responding optimally. When such markets are conducted under the umbrella of an 

academic institution, these markets provide research and teaching purposes, both 

clearly in the public interest. 

3. What calculations, analyses, variables, and factors could be used to 

objectively determine the social value of information to the general public that 

may be discovered through trading in event contracts? Should this be a factor in 

determining whether the Commission plays a role in regulating these markets? 

Calculation of the value of information is a straight forward exercise that is taught in 

almost every business school2

, but it should not be a factor in whether the CFTC should 

regulate event markets. It is impossible to tell ex ante whether any specific event 

1 See the information at http://fluprediction.uiowa.edu/fluhome/ 2 See Pindyck, R Sand D. L. Rubinfeld, Microeconomics, 5th ed. 164-165 for a textbook demonstration of how to 

value improved information. 
market will work well enough to draw interested traders. If it does not work trading will 

dry up.3 

4. What characteristics or traits are common to or should be used to identify 

event contracts and event markets? 

The characteristics that can be used to identify event markets useful for information 

aggregation purposes are (1) a focus on price discovery, and (2) an absence of scale to 

provide an insurance or hedging motive for trading. Arguably, the IEM has performed 

well in prediction because the size limitations and the perfectly elastic supply of bundles 

in those markets make hedging political risk unattractive. In some cases, the existence 

of specialized information must be considered. For instance, aggregating information 

about the likely outbreak of flu is more likely to be successful when those with 

specialized information (doctors, nurses, pharmacists) are included in the trader pool. 

8. Given the purposes and history of the Act, would it be appropriate for the 

Commission to apply any test premised on the economic purpose of certain 

types of transactions to demarcate the Commission's jurisdiction over particular 

contracts? If so, what factors could be used to make such a determination? 

It would be appropriate for the Commission to apply a test on the economic functions of 

the information obtained from the operation of the event market. For example, the 

I EM's markets have primarily had the purpose of teaching and research. It should be 

obvious that those activities have economic value. Other cases may be different. The 

Flu markets provide information about whether, and when, to apply prophylaxes to 

nursing homes. Sales forecasting, as the Hewlett-Packard example showed, would 

have a direct economic effect on a particular firm. 4 

11. What identifiable factors, statutorily based or otherwise, limit the events and 

measures that may underlie event contracts when such contracts are treated as 

Commission-regulated transactions? 

Factors that should limit the events where contracts are treated as Commissionregulated transactions must, of necessity, depend upon the nature of the market, 

especially who is allowed to participate in it. As described in Arrow et. al, it seems likely 

that there will be three types of market organizers: (i) non-profit organizations, including 

Universities, colleges and think tanks; (ii) government organizations (e.g., Center for 

Disease Control, Department of Defense), and (iii) for private businesses and not-forprofits not primarily engaged in research. In some circumstances market enrollment 

may be restricted to .individuals or organizations with special characteristics; in other 

cases, dissemination of the price and/or trading volume statistics may be restricted. An 

event like "Will Fidel Castro live past July 1, 2009?" may be of little interest to the first 

group of markets, but of important interest to the second. 

3 See R L Sandor, "Innovation by an Exchange: A Case Study of the Development of the Plywood Futures 

Contract," Journal of Law and Economics, v. 16, n.1, April, 1973, 119-136. 4 C R. Plott and K Y Chen, "Information Aggregation Mechanisms: Concept, Design and Implementation 

For a Sales Forecasting Problem," Caltech Social Science working paper #1131, March 2002. 
12. What objective and readily identifiable factors, statutorily based or otherwise, 

could be used to distinguish event contracts that could appropriately be traded 

under Commission oversight from transactions that may be viewed as the 

functional equivalent of gambling? 

The distinguishing factor is what the proposing agents plan to do with the information 

once it is obtained. In conventional gambling, the outcome of a horse race, a card 

game or a boxing match has no economic value before or after the event occurs. 

16. Is it appropriate for the Commission to direct certain or all event contracts 

onto markets that are regulated differently from and perhaps less stringently than 

DCMs? 

It is appropriate to treat event markets differently than DCMs because their economic 

function is different. But all event markets should be, up to the question of privacy of 

information, required to have the same standard for resolution and payoff. 

18. Is the issuance of staff no-action relief, such as the relief issued to the IEM, an 

appropriate or preferable means for establishing regulatory certainty for event 

contracts and markets? 

Though a No-Action Letter may not be sufficiently flexible for all event markets and 

contracts, in our experience it works well for markets conducted for research and 

teaching purposes at academic research institutions. Such institutions already have 

audit functions in place to protect assets and research review in place to protect 

institutional and social interests. These functions supply similar oversight to that 

incorporated in regulatory review and we recommend that such oversight be 

incorporated as part of the no-action relief. For instance, because the IEM is a realmoney market, we conform to University of Iowa cash handling procedures and are 

subject to University of Iowa audit. In addition, our trading rules assure that all trades 

are 1 00% cash covered so there is not risk of financial default. 

Signed by the IEM Board of Directors, 

Joyce Berg, Associate Professor of Accounting, University of Iowa 

Thomas Gruca, Professor of Marketing, University of Iowa 

Forrest Nelson, Professor of Economics, University of Iowa 

George Neumann, Professor of Economic, University of Iowa 

Thomas Rietz, Associate Professor Finance, University of Iowa