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Home Front
Terrorism futures trading...
2003-08-10
The political furor which led to the resignation of Admiral John M. Poindexter and forced the Pentagon to abandon launching an online futures trading market in which anonymous speculators would bet on possible terrorist events should not eclipse what was an unprecedented attempt to understand terrorism by synergizing the profit motives of financial markets with innovative management practices and advanced technologies. India should immediately establish a similar multi-disciplinary experiment to obtain fresh insights into predicting terrorist attacks on India.

The Pentagon developed Policy Analysis Market (PAM) as “part of our search for new ways to prevent terrorist attacks...Futures trading has proven effective in predicting events as diverse as oil prices, elections and movie ticket sales”. A senior Pentagon official elaborated: “Research indicates that markets are extremely efficient, effective and timely aggregators of dispersed and even hidden information. Futures markets have proven themselves to be good at predicting such things as elections results; they are often better than expert opinions.”

According to its websites http://www.darpa.mil/iao/FutureMap.htm [Note: appears defunct] and http://www.policyanalysismarket.org [ditto], PAM would “trade on economic, civil and military futures of Egypt, Jordan, Iran, Iraq, Israel, Saudi Arabia, Syria and Turkey and the impact of US involvement with each...” What got PAM into trouble were the events it was taking bets on — assassinations of Yasser Arafat and King Abdullah II of Jordan, a biological weapon attack on Israel, a nuclear missile strike by North Korea, etc. PAM was an initiative of Admiral Poindexter, USA’s National Security Advisor during the Reagan presidency, who was appointed head of the Pentagon’s Terrorism Information Awareness program after 9/11. It was to be launched on 01 August 2003 and was slated to be fully operational by 01 October 2003.

PAM was conceived by Robin Hanson, professor of economics at George Mason University, and was a joint program of USA’s Defense Advanced Research Projects Agency (DARPA) and two private companies — Net Exchange, a San Diego-based market technologies company, and the Economist Intelligence Unit, a unit of the British magazine Economist. According to Brendan I. Koerner, Fellow, New America Foundation, PAM was based on existing futures markets such as Iowa Electronic Markets, in which investors trade futures contracts on US presidential candidates and the US Federal Reserve’s interest rates; Wahl$treet, a futures market on German politics; the Irish betting portal TradeSports.com, which correctly predicted the date of Saddam Hussein's ouster; and Foresight Exchange Prediction Market where traders bet on several types of events, such as the resignation of Donald Rumsfeld by October 2003. Registered traders would deposit money into an account and buy and sell futures contracts on assassinations and coups in the Middle East. Holders of a futures contract that came true would collect the proceeds of investors who predicted wrongly.

PAM’s websites gave some blood-curdling examples:
  • Suppose a trader believes that Jordan’s King Abdullah will be assassinated within the year. Since she holds a minority opinion, she can buy a futures contract on Abdullah being killed at a low price, say 5 cents. As more people follow her example, the price of the killed-king future goes up, to say 35 cents. The payout if the king is killed within the year is a dollar, otherwise nothing. If the king is killed, the early investor makes a profit of 95 cents. The later investors make a profit of 65 cents.

  • Yasser Arafat is more likely to be assassinated than Abdullah. You may buy an early futures contract on this, at say 55 cents. As more people begin to think like you that Arafat is going to be assassinated, the cost of the Arafat contract would go up, to say 85 cents. The payout if he is killed is a dollar, otherwise nothing. So you could make a profit of 45 cents and the others who followed you could make 15 cents if Arafat is killed.
On Monday, 28 July 2003, two Democratic senators, Byron Dorgan of North Dakota and Ron Wyden of Oregon, denounced PAM as “grotesque” and “morally repugnant”. They added: “This encourages terrorists to participate, either to profit from their terrorist activities or to bet against them in order to mislead US intelligence authorities.”

Deputy Defense Secretary Paul Wolfowitz terminated PAM and its websites were deleted. Poindexter resigned after Senator Barbara Boxer, Democrat from California, demanded that Congress “end the careers of whoever thought this up.”

Several experts criticized the termination of PAM. James Surowiecki, financial columnist of New Yorker magazine and MSN’s slate.com opined that America would regret canceling PAM: “Similar markets have proven surprisingly good at predicting elections and box-office sales. Orange-juice futures do a better job of predicting the weather in Florida than weather forecasts do
 Even when traders are not experts, their collective judgment is often remarkably accurate because markets are efficient at uncovering and aggregating diverse pieces of information
 It doesn't matter much what markets are being used to predict. Whether the outcome depends on irrational actors (box-office results), animal behavior (horse races), a blend of irrational and rational motives (elections), or a seemingly random interaction between weather and soil (orange-juice crops), market predictions often outperform those of even the best-informed expert
 It is reasonable to think a prediction market would add to our understanding of the Middle East.” Surowiecki added: “PAM would also have been effective because traders have no incentive other than making the right prediction for profit -- there are no bureaucratic or political factors influencing their decisions -- so they eliminate the hurdles that limit information flow within organizations. That's especially important in intelligence. In 9/11 there was lots of relevant information available before the attack took place. What was missing was a mechanism for aggregating that information in a single place. A well-designed market might have served as that mechanism.”

Senators Dorgan and Wyden’s contention that betting on assassinations is morally wrong is specious since existing currency, stock and commodity markets implicitly factor in such political risks. Also, in a life insurance policy, the policy issuer is betting that you will die later than you think you will, while for an annuity, the issuer is betting that you will die sooner than you think you will. It is also specious of Wolfowitz to terminate PAM on the moral grounds that it was betting on assassinations when the Pentagon has frequently simulated the deaths of Indian leaders in Pakistani-sponsored terrorist attacks. India should immediately establish an exchange similar to PAM, combining the desi genius of Dalal Street brokers with cricket match bettors and IITian mathematical modelers and geopolitical and defence pundits, in order to obtain fresh insights into predicting terrorist attacks on India. Establishing such an exchange would not be expensive. DARPA spent only US$600,000 to develop the PAM software and budgeted US$ 8 million for operational costs for running the futures exchange for two years. The benefits to India of getting Dalal Street to perform undha badla on Hafeez Mohammad Sayeed or Mohammed Azhar or Dawood Ibrahim would greatly outweigh such low investments.

I won't be posting much for the next few days... I have... ummm... an idea.
Posted by:Fred Pruitt

#5  SW - All? Uhhhhh. How about $50K, Fred? Steve will match it, right Steve? And now that I'm on the other side of the table, I get to be the hardass and demand the biz plan meets some insane margins, right? ;->
Posted by: ·com   2003-8-10 11:41:04 PM  

#4  Is it too early for the rest of us to invest? You need a capital partner? I'm happy to invest all of PD's pension into this, so let me know!
Posted by: Steve White   2003-8-10 10:57:35 PM  

#3  Yes, please go, Fred. I thought it an excellent idea — it was one of the few 'outside of the box' ideas I've heard in a while.

We've got to stop thinking traditionally. And Wolfie should have stood up for this one. As much as I distrust Poindexter, this was a good idea.
Posted by: Kathy K   2003-8-10 8:40:55 PM  

#2  Is it legal? I mean the CFTC will have to clear your efforts to create a new bourse but other than that, I see no real objections. I'd ask the Volokh Conspiracy though before I went off and bought land in Chicago...
Posted by: Brian   2003-8-10 5:06:30 PM  

#1  Go Fred!
Posted by: Dishman   2003-8-10 4:39:43 PM  

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