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From: .... rhanson@gmu.edu on behalf of Robin Hanson [rhanson@gmu.edU].TI8 J i. -7 P;i 3: 56 

~~ .~;~ M~:mday, Ju)~'tlf, 200810:13AM 

To: secretary 0 C. 0 -·HE S .CR C:TARIAT 

Subject: Comment on "Concept Release on the Appropriate Regulatory Treatment of Event Contracts" 

[I sent an email with a comment just before midnight last night, as I feared that was the deadline for 

comments. I have since heard that you are likely to accept comments through the close of business 

today. I have edited my comments from last night somewhat for readability- please substitute the 

following comment for the one I sent last night. Robin Hanson] 

I am an event market innovator, having published the first detailed discussions envisioning their 

widespread application, having designed a widely used trading mechanism (the market scoring rule), 

and having co-developed the first internal corporate markets (at Xanadu), the first public web markets 

(the Foresight Exchange), and the aborted-but-influential Policy Analysis Market. 

As I am less well trained in law than social science, I will not comment on what the C.F.T.C. is legally 

authorized to do, but only on how various policies correspond to public interest and public opinion. I 

speak here only for myself and not for any organization with which I may be affiliated. 

The degree and type of regulation appropriate for a financial market depends on traders' motives. Long 

ago most everything beyond direct physical exchange was widely discouraged or prohibited as 

"gambling" or "speculation." The motives imputed to traders seemed to be some combination of 

mistakes, overconfidence, thrill of action, love of risk, and showing off one's confidence and risk 

tolerance. 

While public opinion on gambling has changed little, eventually legal exceptions were carved out for 

markets where, though speculation was still possible, enough participants had more sympathetic motives 

to gamer public support. Securities markets allowed business managers to hedge ownership, insurance 

markets allowed hedging of various idiosyncratic risks, and commodities futures markets allowed 

hedging of various common risks. 

It has long been noted approvingly that such speculative markets often had the desirable side effect of 

inducing people to collect info and aggregate it into prices. But until recently such info was not 

considered or accepted as a primary explanation or justification for a market's existence. Given the 

myriad ways our society now suffers, often dramatically, from failures to aggregate info, I am very 

optimistic about the long term potential for such markets to offer substantial social value. However, the 

question remains of how such info-motivated markets should be regulated today. 

Ideally an entire new regulatory regime would be carved out, on par with regimes for securities, 

insurance, and commodities futures regulation. But who would bother with such an effort before such 

markets had proven themselves able to realize substantial social value? And how could such markets 

prove themselves without at least tentative legal spaces in which to experiment? I know of no good 

reason why the C.F.T.C. should not provide one of the first such spaces. 

Two key issues face a new regulatory regime for info-motivated event markets, especially one carved 

out of a common-risk-hedging commodities-future regulatory regime: 

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• How does optimal regulation of info-motivated event markets differ from that of common-riskhedging markets? 

• How can regulators ensure that this new regime is not used as a back door to escape prohibitions 

on other commodity futures trading, or to escape general prohibitions against gambling? 

How Does Optimal Regulation Differ Here? 

On the first question, the largest difference I see, by far, is the appropriate scale. When hedging risks it 

makes sense to focus first on risks, and hence trades, which are a large fraction of the wealth of the 

individuals or organizations involved. If risks are common there should be many who trade if any trade, 

and so market volume should be many times individual wealth levels. It also makes sense to devote a 

small fraction of this volume to efforts to avoid foul play. I have heard that it costs on the order of a 

million dollars to jump the regulatory hoops to gain approval for such markets, and I cannot say that this 

is not roughly the right cost magnitude. 

For markets whose main function is to collect info, however, the appropriate scale seems far smaller. To 

collect info on a topic, those who know or could find out need only be offered a sufficient incentive to 

bother. In the lab, experimental economists see substantial effort and price info aggregation when only a 

few tens of dollars are at stake, and field data seems consistent with this estimate. If most of the social 

value from info-motivated event markets were concentrated in a few very important topics, it would not 

matter much if regulatory barriers prevented markets on topics with small info values. But if, as seems 

more plausible, much of the value is found in a long thick tail of smaller topics, then to realize this 

social value it is essential that regulatory barriers to creating such markets be reduced to the lowest 

feasible level. 

For example, consider a topic where a social value of one thousand dollars could be realized, if only 

people were allowed to trade in a market on that topic. It is hard to see how this value could actually be 

realized if the regulatory cost to create this market were more than a few hundred dollars. If there were 

a million such topics, the total social value such markets could create would be one billion dollars. 

A related difference is when it makes sense to limit participation. If most of a certain kind of risk is held 

by wealthy individuals or large organizations, then it can make sense to limit participation to such 

traders. But for info collection it is crucial to allow participation by the sorts of people who could 

plausibly obtain that info. For a great many topics these people will be spread out in the population, and 

not easily distinguished from most other people. A broad permission to participate will thus be desired 

in such cases. 

How Can We Distinguish When This Regime Should Apply? 

On the second question, we seek a reliable way to distinguish markets where the info collected is a 

strong rationale for its existence, a rationale strong enough to justify overturning the usual public 

presumption against generic speculation, and strong enough relative to hedging rationales to justify 

using this new regulatory regime, rather than other hedging regulatory regimes. 

One proposed distinguishing criteria includes the size of an individual trader's stake, and the number of 

traders. The Iowa Electronic Markets are limited on both of these parameters. Such limits do succeed in 

preventing large hedging markets from masquerading as info-motivated event markets. But they do 

little to prevent generic gambling markets from masquerading as info-motivated event markets. 

Another proposed distinguishing criteria is the form of the organization that hosts the market. Some 

have proposed that tax-exempt, research, and government organizations be given wider latitude than for7/7/2008 
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profit businesses. I understand that this matches a common public perception, but honestly it seems 

mostly wishful thinking to believe that such organizations are substantially more likely to create markets 

with a strong info rationale, or to avoid whatever problems one fears with for-profit businesses. 

Some have suggested that topics could be used to distinguish the strength of info rationale. Markets on 

sporting events might be presumed to have low info rationale, while markets on public policy might be 

presumed to have high info rationale. This approach seems to open a proverbial "can of worms," 

however, requiring a great and continuing effort to categorize topics. 

To ease this effort, one could inherit some other topic categorization. For example, regulation of speech 

distinguishes topics where free speech is presumed to perform very valuable social functions, and so has 

strong legal protection, from topics where such functions are less clear, allowing speech to be more 

easily regulated. Event markets might be permitted on topics where free speech has a strong legal 

protection. 

In contrast to such weak indicators let me propose a stronger indicator of when a speculative market has 

a strong info rationale. I am not proposing that only markets which sport this indicator be allowed, but 

rather that at least such markets be allowed. My proposal is to permit markets where a sponsor pays 

to ensure that traders on average do not lose fmancially from participation, as this payment creates 

a strong presumption that this sponsor expected to gain substantial value from that info. 

It is hard to see many of the benefits that traders may gain from trading, but we can more easily see the 

average financial costs that traders suffer. Traders may have to pay for permission to trade, to deposit 

into a system, to check prices and trading history, for each trade, and to withdraw their winnings. In 

addition, trader deposits may not earn competitive risk-adjusted rates of return. Payment is sometimes 

in the form of seeing ads. Such fees are essential to the profitability of "gambling" businesses today that 

rely primarily on traders' speculative motives. 

If for a particular topic, a sponsor were willing to ensure that traders paid none of these common trading 

fees, that sponsor would have credibly suggested that his or her market would not exist if that sponsor 

did not expect related info to have substantial value. If this sponsor furthermore subsidized this market, 

allowing traders to gain on average by trading against ignorant automated market makers, this would 

show even more clearly that this sponsor valued the resulting info. Such measures would ensure that 

traders suffered no average financial loss from their participation, though traders could still lose on 

average, such as by wasting too much time dealing with these markets. 

Of course we do not expect sponsors to arise to support all topics where info collected by trading would 

have substantial social value. We expect businesses to sponsor markets on topics where they can profit 

from info, and charities to collect donations to support markets on topics they consider more broadly 

valuable. But we also expect many coordination failures, where each party prefers that others pay for 

commonly valuable info. So the case for prohibiting markets that fail my proposed criteria is much 

weaker than the case for permitting markets that meet this criteria. 

It also remains possible that even when a sponsor finds info to be valuable enough to pay for, the social 

value of that info could be much less than the private value to this sponsor. If we could identify classes 

of such cases, these classes might form the basis of exceptions to this general permission I propose. 

I have many other opinions about how such markets might be defined and regulated, but I've already 

gone one for quite a bit here- if you like what you see here and want more, you know where to find me. 

In Summary 

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In addition to existing regulatory regimes for ownership-hedging securities, idiosyncratic-risk-hedging 

insurance, and common-risk-hedging futures, it could make sense to have a distinct regulatory regime 

for markets whose main reason to exist is the info that they collect. Compared with existing 

commodities futures regulation, such a regime should set a much lower barrier to creating such markets, 

as much of the social value may be distributed in millions of small markets. And while it is hard to 

determine in general which markets would create high social info value, relative to cost, we should 

presume such high value when a sponsor is willing to pay to ensure that traders suffer no average 

financial cost from their participation. 

Robin Hanson rhanson@gmu.edu http://hanson.gmu.edu 

Research Associate, Future of Humanity Institute at Oxford University 

Associate Professor of Economics, George Mason University 

MSN I 03, Carow Hall, Fairfax VA 22030-4444 

703-993-2326 FAX: 703-993-2323 

7/7/2008