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Avian Flu emerges as the new lighting rod for predictive futures markets


On 1 November 2005, Intrade, announced "Trading on Bird Flu -- 65% probability of U.S. case by March 2006!" with regards to its trading activity on H5N1 avian flu contracts:

Intrade launched its two bird flu contracts -- one predicting that the potentially deadly, pandemic-causing Asian bird flu will hit the U.S. in December, the other that it will hit in March -- on Oct. 18. (The December contract is now trading at 6, meaning the market is currently predicting a 6 percent chance of the flu hitting the U.S. on or before Dec. 31, the March at 29.6.) [The] the bird flu contracts are among the most popular on the futures markets site, and [Intrade] expects betting on the bird flu only to increase as the contracts' closing dates -- Dec. 31 and March 31, respectively -- approach and as more cases of the bird flu crop up around the world.

Contracts on the Intrade exchange can be bought or sold between other members... If, for instance, someone purchases a December bird flu contract at a purchase price of, say, $16, and a strain of H5N1 is confirmed in the U.S. on or before Dec. 31, that person wins whatever his or her buy price is against 100. In other words, the profit on each contract purchased at that price will be 100 minus 16, or 84 points, multiplied by 10 cents per point or $8.40. (Because contracts trade between 0 and 100 "points," you can think of the price at any time to be the percentage probability of that event occurring.) According to Keating, most investors buy about $500 worth of shares.

These trades are the best predictors yet of the appearance of H5N1 on US soil, yet they are being attacked as was DARPA' aborted Policy Analysis Market (PAM), part of Futures Markets Applied to Prediction (FutureMAP) program, in October 2003. The superb, but politically tone-deaf PAM website was removed by the afternoon after being attacked on the Senate floor:

You ask whether there are traders or traitors--T-R-A-D-E-R-S or T-R- A-I-T-O-R-S. As we understand it, even terrorists would be allowed to bet on the likelihood of future terrorist attacks... this is perhaps the most irresponsible, outrageous, and poorly thought out of anything I have heard the administration propose to date. For the life of me, I cannot believe anybody would seriously propose that we trade in death, that we set up a futures market on when, as the Web site proposed, the King of Jordan could be overthrown, when a leader would be assassinated, when a terrorist attack would occur. Most traders try to influence their investments. How long would it be before you saw traders investing in a way that would bring about the desired result?

I am reminded of similar civilian unease with the likes of megadeath, spasm response, and counterforce collateral damage as the defense intellectuals of the 1960s, which included Albert Wohlstetter, Bernard Brodie and Herman Kahn, attempted to reduce emotion in the emerging field of strategic analysis. "In the early 1960s, Kahn was the most public, and notorious, expert in this new field of strategic analysis [eventually becoming] the model for Dr. Strangelove in Stanley Kubrick’s movie."

Much of the concept of applying commodity-style trading markets and combinatorial betting technology to war gaming rose with Robin Hanson at George Mason University. Zillman has a fine bibliography on prediction markets and futures here and here, while GWU has a good directory of the PAM-related items. I side with Jack Marshall of Pro Ethics on both the "wisdom of crowds" aspect of futures markets removed of bias and the benefit, rather than harm, of these futures markets betting on Avian flu and other events:

"It would be different if, say, after 9/11 people are betting on where the next person's remains would be found, but this is far less sinister than that... In postmodernist America we have a black humor and a detachment from a lot of catastrophe anyway. Betting on an abstract event, buying futures in abstraction doesn't necessarily make things any worse."

Spann and Skiera have some useful pointers on the value of a virtual stock market (VSM) that employs the efficient market hypothesis, i.e., a "market is efficient if all available information is always fully reflected in the prices," in order to create stocks with payoffs dependent upon the market outcome and allow participants place futures according to their opinion of the outcome.

Internet-based virtual stock markets (VSM) can be used to:

predict future market developments and events of political, as well as business and economic interest. The basic idea of such a VSM is to bring a group of participants together via the Internet and let them trade shares of virtual stocks. These stocks represent a bet on the outcome of future market situations. Their value depends on the realization of these market situations, thus making the stock prices a predictor of these market situations. Basically, virtual stock markets are a method to organize Internet-based interactions with experts, consumers and other persons in order to elicit their information concerning future events. Such types of VSMs have been applied successfully in the field of political forecasting for over a decade, showing a high predictive validity, often outperforming opinion polls in terms of forecast accuracy.

Spann and Skiera proceed to describe the design criteria for a VSM:

  • Choice of the forecasting goal (formulating the payoff rule, selecting duration and selecting or attracting a savvy group of participants)
  • Creation of incentives for participation and information revelation (performance based rewards based upon participants investing their own money or vying for shares of virtual stocks and virtual money)
  • Financial market design (tested design that meets the risk appetites of the participants, the structure of the goal, satisfaction of any and all legal and political jurisdictions, et al

VSMs work when the:

  • Future market condition/event to be predicted are clearly stated so that participants' expectations correlate to the "stock" dividend
  • Participants have threshold knowledge about the future market situation to be predicted
  • Payoff mechanism incents the participants "to invest their time and participate as well as reveal their true valuations"

VSM can be applied to:

any quantifiable business-forecasting problem where potential traders possess relevant knowledge. [Examples are] any binary event (e.g., bankruptcy, litigation victory, change of management or successful product introduction) [as well as gradated] sales, market share, profit, company stock price or time-to-market of new product introductions [and] foreign policy events... any event in the public domain [such as] voting behavior... economic indicators [and] rates set by the Federal Reserve Bank.

Use of VSMs in such areas as aborted "policy analysis market" include:

  • Nontraditional means of evaluating, by means of a stock price, an otherwise ambiguous condition
  • Aggregation of information by an "objective" market mechanism independent of the hierarchical position of the trader
  • Capacity to "obtain further information from the "outside"
  • Integration of information which "otherwise might have been buried in large documents or hierarchies"
  • Identification of persons or agencies that excel in prediction

We need more such markets, not fewer, as we need better visibility and prediction of events critical to our economic and strategic wellbeing. Such markets can also force governments, ours and others, to publicly confront issues that they might otherwise shirk.

Betting on Bird Flu
New York Times
December 17, 2005

Betting on bird flu
A growing market allows investors to make money off of disease and natural disasters. And so far, their predictions have been dead-on.
By A.J. Daulerio
Dec. 13, 2005

Prediction Markets and Information Futures
By Marcus P. Zillman
Virtual Private Library
April 2005
Also at Prediction Markets in HTML

Man and Machine in the 1960s
Sungook Hong
University of Toronto,
Seoul National University
Techné 7:3 Spring 2004 Hong, Man and Machine / 49

Taking Stock of Virtual Markets
By Martin Spann and Bernd Skiera
OR/MS Today - October 2003
Institute for Operations Research and the Management Sciences

Business intelligence worth betting on
By Dan Farber, Tech Update
July 31, 2003 9:35 AM PT

The Case for Terrorism Futures
By Noah Shachtman
02:00 AM Jul. 30, 2003 PT

Pentagon Folds Hand in Online Terrorism Futures Scheme
By Roy Mark
July 29, 2003

Congressional Record: July 29, 2003 (Senate)
Page S10082-S10083

Pentagon Prepares A Futures Market On Terror Attacks
New York Times
July 29, 2003


Idea Futures
(a.k.a. Prediction Markets, Information Markets)
by Robin Hanson

Gordon Housworth

InfoT Public  Strategic Risk Public  


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