Policy analysis market: benefits and disadvantages of operation

¶ … Policy Analysis Market Over Its Disadvantages Had it Been Able to Operate

Conceived and developed by the United States' Defense Advanced Research Projects Agency (DARPA) on an idea from Net Exchange, the Policy Analysis Market was a revolutionary concept that combined the market economy, stock exchange rules and trading with geopolitical and geostrategical issues, especially based on the conflicts in the Middle East. The idea of this market was that it would allow trading on future contracts "based on possible political developments in several Middle Eastern countries," extended to events such as terrorist attacks or assassinations (it was also referred to as "terrorism futures").

Further explaining this, the base asset that would have been made the object of transaction was information. In fact, the price of the future contracts was based on the probability of the respective events occurring and this probability, hence the price itself, was determined by the opinions of strategy and policy makers and would reflect the information available on the market at a certain point related to whether these events are likely to occur or not.

As a short history, in 2000 Michael Foster convinced Defence Advanced Research Projects Agency about the importance of this kind of studies so that in 2001 the funding for these programs began. The funding should be made in two Phases. As a first negative result is that in Phase 1 after several studies and trades on different markets, a group of students used a complex simulation for a few days in witch they made real money, but the result was a failure. The official site used as main images some violent acts with known political personages as the assassination of Arafat and the North Korean attack and this already brought the project in somewhat of a dark light, because it emphasized the bleak aspect of the project, its concentration on predicting assassinations and terrorist acts. On complaints from U.S. senators, on July 29, 2003, the project was stopped.

Persons as Dr. Robin Hanson, an economics professor at George Mason University, tried to explain that those images on the site were misunderstood as its meaning was that all if them showed scenes of changes, regime changes witch involved changes on the political, social field in a country. Therefore, the violence of those images could have been used to better explain changes and not only to trade or make a profit on violence or terrorist activities in the region. Nevertheless, the image of the project was largely negative among those categories of individuals less informed about what PAM was really about.

The first main advantage of PAM was that it allowed people to "tap into the collective wisdom of a population." Basically, this is a popular way of saying that PAM and the system that PAM proposed allowed for (1) the increase in accuracy on future political evolutions in the Middle East and (2) a better availability and transparency for this information to a larger category of individuals. Let's look at both these aspects and analyze them in part.

PAM's bet was that an efficient market bases its price evolution on information and, most notably, on the accuracy of that information. This means that prices are formed depending on how correct evaluations, analysis and research is, reflecting as closely as possible the realities of the world. In this particular case, PAM would have allowed people to research more in order to obtain reliable data in the Middle East and this would have led to conclusions, solutions, strategies more applied and better based on actual realities in the region. Clearer investigations, better evaluations and a general better organized campaign to obtain data and facts about the region, all in order to create accurate investing decisions on PAM, would transpose to the political and geostrategical decisions as well.

Robin Hanson showed that one of the most important causes for bad policy decisions is represented by a "lack of information." In its role as partially a speculative market, PAM would have, in his opinion, provided a real coagulating force and would have substituted the job of 'aggregating information'.

A second important advantage we need to bring into discussion is the hedging risk that this type of market could have played on the global market. Indeed, almost all primary markets have a secondary market on which risks are hedged. Geopolitical risks, typically associated with the Middle East and that region, could have been hedged by taking a different position on the PAM, a secondary market for this type of assets. The example of oil companies, very affected by the geopolitical changes in the region, comes to mind as primary beneficiaries of this particular advantage.

Certainly, among the main disadvantage or at least objection, was that the market was too exposed to the manipulation of evildoers, namely terrorists that could use PAM as the best way to fund their actions. The mechanism would be simple: terrorists would simply bet on the occurrence of certain terrorist events, they would produce them and see them gain on the Policy Analysis Markets. This assertion is not entirely untrue and can certainly be considered a probability.

However, as theoreticians pointed out, terrorists would not necessarily need an additional market to produce such a scheme. Indeed, the oil market, the air transport companies shares or other shares determining assets affected by the Middle East events and by global terrorist activities, provided enough perspectives to fund terrorist actions, basing this assertion on the fact that terrorists could simply sell short these types of shares and obtain money on their decrease after the event.

Additionally, theoreticians pointed out that PAM would have limited investment to a certain sum, most likely $100, which would have made it less profitable when large sums of money, such as needed to finance terrorist actions, were needed.

In my opinion, the morality of the action itself, the ethics in the background, were a significant disadvantage for the PAM project. The idea itself of betting that something bad will happen in the Middle East, the idea of wanting an unfortunate event to occur so that one could gain on the futures market was something that was deemed deeply immoral and unethical.

Some were keen to show that there are numerous other events in life when one bets on misfortunes occurring and that these are, in any case, things that are bound to happen. The insurance industry, for example, is also an industry basing its return on investment for an individual on an unfortunate event and it is not blamed to such a degree.