Martin Devon comments thoughtfully about an innovative approach to evaluating geopolitical risk. He also quotes a couple of idiot pols who are agin’ it.
If you can create a real-money market in risk evaluation, it’s usually a good idea to do so, if only for price-discovery (in this case, risk discovery) purposes. People in the aggregate, voting with their own money, generally make better bets than do individuals who are merely writing position papers. And creating a market in risk assessment facilitates the pooling and hedging of risk. Of course these are the same principles that underlie insurance markets, which may be why some pols don’t like them. Imagine: individuals and businesses dealing with risk on their own, without needing politicians to “help” them. Too bad there’s no organized market for hedging away Congressional risk.
UPDATE: From Instapundit’s post on this topic and the comments here, there seem to be several objections to this idea. I paraphrase some objections (italics), below, and then respond. (Feel free to leave additional comments if I left anything out.)
Moral hazard: terrorists or other bad guys might cash in by betting in advance of their own terror attacks, or by committing terror attacks solely to make money. There is also incentive for govt officials, journalists, et al to manipulate the market by hyping nonexistent risk and then taking the other side of trades made by people who are betting on an attack.
There may be reason for concern, but it’s already possible to bet on terrorism: all you have to do is buy a large quantity of stock-index puts. And trades of this type, especially in a market dedicated to terrorism risk, would serve a valuable function by telling the world that something was up (in much the same way as an out-of-nowhere jump in the price of a stock may suggest that a takeover bid is imminent). The more narrowly tailored the market was — e.g., an assassination market for a particular leader — the more useful the information so transmitted would be. I think the benefit would probably outweigh the moral hazard, though I may be wrong.
With respect to people falsely hyping nonexistent terror attacks, markets are effective at discriminating this kind of false alarm. The first time it happened the market would probably move significantly, but after one episode of crying wolf the same tactic might not work again. It might also be possible to create legal penalties for false alarms. Such penalties wouldn’t deter everyone, but would at least impose a high expected cost on anyone who had something to lose, e.g., government officials and journalists, who are also the kinds of people most likely to be able to move the market by hyping terrorism concerns.
Innocent people might avoid participating in the market because there is a hypothetical risk that they would be arrested for knowing too much if they profited from terrorism predictions.
I don’t know. Whether this is an issue probably depends on how many people use this market and how much sense the government has. And it’s only a problem if they arrest innocent people. If they arrest guilty people it’s a benefit.
Information about pending terrorism is by nature private, and therefore public markets such as the envisioned terrorism-futures market would not be useful to predict attacks. As Glenn Reynolds put it:
An InstaPundit reader who is too smart to be in Congress emails with a more meaningful criticism: the futures market won’t identify “unknown unknowns,” since the betting — as with ordinary futures markets — must take place within the context of standard “products.”
It’s true that a public market would not discount private information, a.k.a. “unknown unknowns.” That’s generally true of markets. However, markets have a good record of making predictions based on publicly available information. The mistake is to compare a futures market to a crystal ball. The real comparison should be between the futures market and “expert” analysts who have no accountability for their biases. Markets look good by this standard, and the government could still do its own private research, much as financial firms do proprietary research in stock and futures markets, to supplement what it learned from public terrorism-risk markets.
Also, private information may become public if there’s money to be made. That’s a big advantage of markets in this case, as publicizing incipient terror attacks brings better countermeasures or the possibility that the terrorists will call off their attack.
It’s wrong to bet on misfortune and people’s deaths.
If this assertion is true, insurance is immoral, as are futures markets in agricultural commodities (betting on crop failures!) and stock indices (betting on, um, misfortune and people’s deaths). These markets are insurance by another name and are just as useful.
The reinsurance industry already does what terrorism futures are supposed to do.
This is partly true, though the reinsurance market operates largely out of the public eye and therefore may not transmit information as well as a futures market would. But if it’s really true that a futures market is unnecessary, then a futures market won’t succeed. It’s impossible to know for sure without trying.
If we’re lucky, someone overseas, like Tradesports, will start offering systematic opportunities to bet on terror-attack odds. Unfortunately, DARPA’s idea has unleashed so much demagoguery by American pols that it may be some time before anyone will be willing to set up such a futures market, even outside of the U.S. Pity.
Virginia Postrel has additional relevant links here.
