Information markets as games of chance.

• Author: McCarthy, Ryan P.

INTRODUCTION

Humans set up vast machinery to control uncertainty. In pursuit of firm answers, we assemble smart deliberators and take their "verdict" as correct; we consult experts; we poll our peers. (1) But recent experiments suggest that one metric--the price signal--can produce startlingly accurate predictions of uncertain events. (2)

In an information market, people trade shares in uncertain outcomes. (3) A now-infamous experiment demonstrates how information markets can work in a practical setting. In 2001, the U.S. Department of Defense and other federal agencies launched a pilot project called the Policy Analysis Market in order to predict trends in global politics that could affect U.S. interests. (4) Prices of shares in the market would indicate whether participants thought certain events were probable or improbable. For example, one "future" was the military preparedness of other nations. (5) Put simply, a high price would predict a high level of preparedness. The government scuttled the market after a political backlash in 2003, but the example illustrates how information markets can serve as an "important supplement to deliberative processes." (6)

There are good reasons to believe that groups can come up with better answers than individual experts. (7) But when groups, such as teams of government officials, assemble to solve problems, they commonly fall into "groupthink." (8) Members may, for example, erroneously defer en masse to an apparently knowledgeable individual, or they may decline to air unorthodox views for fear of extrinsic social consequences. (9) These flaws can produce unwise decisions.

An information market, like a deliberative group, "aggregate[s] information ... about future events." (10) But what distinguishes the information market is the availability of the price signal. (11) When a future uncertain event is identified, players bid on chances based on whether they think the event is likely or unlikely to occur. The price at any point in time represents the players' "collective consensus" on the likelihood of the outcome. (12)

Cass Sunstein argues that information markets can correct for the problems inherent in deliberative groups by

impos[ing] the right incentives for people to disclose the information that they hold.... [I]n a deliberating group, members often have little incentive to say what they know. By speaking out, they provide benefits to others, while possibly facing high private costs. Information markets realign incentives in a way that is precisely designed to overcome these problems. Because investments in such markets are generally not disclosed to the public, investors need not fear reputational sanctions if, for example, they have predicted that a company's sales will be low or that a certain candidate will be elected president. (13) Because people must put their own money at risk in an information market, they tend to use the knowledge they have. (14) "Insiders" act on closely held knowledge, which makes prices reflect reality to the greatest possible extent. (15)

Despite the conspicuous fate of the Policy Analysis Market, successful counterexamples abound. The Iowa Electronic Market (IEM) is perhaps the most famous information market. (16) It allows traders to wager a limited amount of real money on a variety of future events. (17) In a consistent and well-publicized stream of successes, IEM traders predicted the results of four U.S. elections within a very small margin of error. (18)

Another popular market is the Hollywood Stock Exchange (HSX), which is similar in most respects to the IEM except that its traders use "play money." (19) Participants trade "virtual" shares in actors and movies and attempt to predict box office revenues. (20) The information the market produces is accurate enough that "HSX has started to sell data collected through the Exchange to the major studios which can profit from accurate predictions of film revenues." (21)

Perhaps the most ambitious view is that markets can improve government decision making by aggregating views on what policies are likely or unlikely to work. Economist Robin Hanson proposes, for example, that we "vote on values, but bet on beliefs"--that is, we should rely on democracy to identify "what we want," but "let speculative markets say how to get what we want." (22)

In a 2002 article, Tom Bell explored the feasibility and legality of markets for "science claims"--theories that eventually would prove to be true or false. (23) Bell identified the concern that such markets might run afoul of state and federal gambling laws, concluding that the legal analysis is "uncomfortably uncertain" (24) due to a "dearth of controlling cases or clearly applicable statutes." (25) More recent analyses have also identified this problem and have cautioned that the apparent similarity between information markets and gambling may prevent information markets from thriving. (26)

This Comment shows why policymakers should view this legal uncertainty with seriousness. As experiments suggest, the advantages of information markets are not limited to tax revenue and amusement--the perks that recommend activities that traditionally would be called gambling. Information markets promise second-order benefits--possibly even new product markets for predictions, as in the case of HSX. An ambiguous legal status discourages experimentation in two dimensions: first, prospective operators of information markets may be deterred by the threat of prosecution under state or federal gambling statutes; (27) and second, payment-system providers could refuse to provide liquidity to traders in nascent markets. (28)

In the years since the Internet has emerged as an economic force, law enforcement authorities (29) and academics (30) have begun to confront the new problems of online gambling. The information market straddles a blurry line between legitimate commerce and illegal gambling. As online entertainment renews regulatory concerns about gambling, it is important to determine the place of information markets in U.S. gambling law. (31) The specter of enforcement in an era of increased visibility of "problem gambling" may deter social experiments and chill the development of valuable new products.

This Comment presses two claims. The first, a descriptive claim about gambling law doctrine, is that some information markets are not clearly illegal games of chance, but the question is close enough to warrant concern. The second, a normative claim, is that information markets are distinguishable from most traditional gambling forms, and for that reason governments should consider allowing information market experiments to thrive without the threat of prosecution. To that end, I propose a carve-out in state gambling laws for specified information market experiments. History reveals a variety of exceptions to serve other ends, and I argue that information markets deserve similar treatment.

Part I provides a brief history of chance games and the vexing problems of prohibiting and regulating them. It reviews policy rationales for government involvement in gaming and outlines the associated problems of clarity, consistency, and enforcement. Part II considers whether or not information markets are clearly illegal under current state and federal gambling laws. Part III presents a rationale for encouraging experimentation in information markets and proposes an exception in the gambling laws to accommodate such experimentation.

1. GAMES OF CHANCE

   Deciding whether information markets are properly classified as games of chance, and determining whether the law should treat them that way, requires a brief excursion into the nature of chance games and the history of the uneasy relationship between gambling and the state.

   1. Historical Overview

      Playing the odds is among the oldest human rituals. Archaeological discoveries, (32) literary works, (33) and early laws (34) reveal chance games--sometimes with prizes--that span swaths of space and time. Since gambling (defined broadly as "making a bet" (35)) is widely regarded today as a vice, (36) one might guess that it was stigmatized throughout modern history. It was not. Chance games--legal and otherwise--were commonplace in American colonial culture, and they sometimes served important social and economic ends. (37) People embraced lotteries because of their large revenue potential and their usefulness in bolstering civic and cultural institutions. (38) Importantly, government leaders realized that "raffles offered a more painless method of raising cash than did the imposition of a new tax." (39)

      Legal gambling in America waned in the early twentieth century. (40) But states again embraced lotteries beginning in the 1960s because of the potential for state-run games to raise revenue and ease the tax burden on residents. (41) Over time, moral objections to gambling increasingly yielded to apparent economic interests. Lawrence Friedman argues that the historical growth in popularity of "vices" such as gambling is emblematic of the early twentieth century cultural change that followed the repeal of Prohibition. (42) He further argues that states, seeing the revenue potential, rushed to exploit the movement in mores. (43)

      At the end of the twentieth century, gambling was widespread; about seventy percent of Americans in 1998 admitted to gambling during the previous year. (44) By 2001, thirty-eight states and the District of Columbia had government-run lotteries, (45) and those programs appeared to have broad public support. (46) Sports betting, a very different kind of game, is also wildly popular. (47) Although legal sports bets can be placed through casinos in Nevada, it is estimated that up to ninety-nine percent of all sports betting in America is illegal. (48) It seems to be particularly attractive to young people. (49)

   2. The Government's Interest

      If a chance game is such an economically potent (and...