The heat of the presidential primary races brings us a new application for prediction markets. Long-used to predict the outcome of presidential elections, these markets are now being deployed to measure economic and strategic variables conditional on who is elected president. The for-profit firm Intrade is offering (for no transaction fee) a variety of conditional markets designed to predict oil prices, long-term interest rates, government debt loads, and the number of troops in Iraq depending on who wins the 2008 election. This forecasting tool has the virtue of capturing the market's best guess about the state of the world after the election, which thereby informs our views of the election. For example, if the market thinks that the number of troops in Iraq will be the same whether Obama or McCain wins in November, this tells us that perhaps we shouldn’t vote based on this issue since the wisdom of the crowd says it isn’t one. Or, if we are a firm interested in oil prices or interest rates (which one isn’t?), these markets may provide very useful information about future uncertainties.
Of course, these conditional markets have great appeal and wide possible application in the corporate law world too.
Last year, Professor Michael Abramowicz and I published a paper that described and extolled the virtues of these markets as possible solutions to a variety of corporate law problems. Most obviously, and directly related to the new markets offered by Intrade, firms or shareholders could create markets estimating the future stock price of a firm (or other key metric) depending on who is named CEO or to the board of directors. This information could also be used to calibrate executive compensation levels, by estimating the impact of different pay packages on the firm's future performance.
Far from being fantasy, these markets are being deployed by firms in the same way that the Intrade markets are. I recently participated in a global strategy conference sponsored by a large consultancy, and the firms participating in the panel and in the audience discussed dozens of private markets using conditional tools to unlock forecasts of this kind.
The biggest concern for these executives, and the reasons these markets are secret, is worry about litigation given the uncertain regulatory status of these markets. There is a tremendous demand for these markets in large companies, and making them more open and notorious where possible would be a great boon to innovation in this area. The government should act preemptively to clarify the regulatory treatment (preferably little or none) to remove the uncertainty for firms experimenting with these markets.