Here at PB.com we are big fans of prediction markets, such as Tradesports, looking to them for predictions as to everything from election outcomes to Supreme Court nominations to indictments and so on. A couple of economists have just posted a very interesting paper, which raises five unresolved questions about the efficacy of prediction markets. Two of the most interesting questions (at least from my perspective) are: (1) how to attract uninformed investors and (2) how to prevent manipulation. These issues raise a question we discussed here a while back; namely, whether prediction markets should seek to ban insider trading. Watching whether prediction markets voluntarily ban insider trading will tell us something about the longstanding debate over the merits of the insider trading prohibition in the stock market.
Indeed, here is a free suggestion for somebody out there with more empirical research skills/interest than I have:
One of the traditional rationales for the SEC prohibtion of insider trading in stocks is that insider trading harms investors and thus undermines investor confidence in the securities markets. If this were true, however, we should see firms voluntarily seeking such prohibitions. In light of the now 40+ year old legal prohibition of insider trading, however, we lack empirical data on this question. Watching whether prediction markets voluntarily adopt bans on insider trading thus might be informative. Of course, I suppose there also might be transaction and enforcement costs explanations why we don't see such proscriptions. Could a good empiricist design a way of sorting out those confounding effects?
