Defense Dept. Program Taking Terror Bets

POSTED: 3:20 p.m. EDT July 28, 2003

A new Department of Defense program allows traders to bet on the likelihood of future terrorist attacks.

The department's "Defense Advanced Research Project Agency" designed what it calls the "The Policy Analysis Market."

The program works much like the financial markets where traders buy and sell "futures" based on the possibility of a specific event in the Middle East, 11 News reported.

Some of the examples listed on the agency's Web site include the assassination of Palestinian leader Yassar Arafat and a missile attack by North Korea. Bidders would profit if the events for which they hold futures occur.

Defense officials said the market-based system is highly accurate when assessing such things as political and civil stability, economic health and military disposition of Middle East countries.

Participants would only have to pick a username and password to participate and the agency said it won't have access to their identities or funds.

But critics said this allows terrorists who are planning an attack to profit on the assault or even make false bets to mislead authorities.

Members of Congress said the market idea is not only wasteful, but repugnant.

"I think this is unbelievably stupid. That is a gentle thing to say about a program that is so devoid of value," Sen. Byron Dorgan, D-North Dakota, said. "It combines the worst of all our values in my judgment. It's a tragic waste of taxpayer money. It will be totally offensive to almost everyone."

"[The] idea of a federal betting parlor on atrocities and terrorism is ridicules and grotesque," Sen. Ron Wyden, D-Oregon, said. "The bizarre plan we are describing today is a waste of taxpayer money and it needs to stop immediately. The program's intent is clear: the federal government is encouraging people to bet on and make money from atrocities and terrorist attacks."

Registration for the site begins Friday and will be limited to the first 1,000 traders. Actual trading will begin Sept. 1 and the Department of Defense plans to open the site to 10,000 traders by Jan. 1, 2004.

Stay with TheWBALChannel.com and WBAL-TV 11 News for the latest news updates.

From Becoming a Pam Trader:

PAM is intended to have a globally distributed population of traders. Individuals interested in the Middle East and in the involvement of the United States with the countries of the Middle East are welcome to register as PAM traders. Individuals who are interested in the use of market processes to manage risk are also welcome to participate in PAM. Whatever a prospective trader’s interest in PAM, involvement in this group prediction process should prove engaging and may prove profitable.

Trader registration will open on August 1, 2003 and will be accessed exclusively through this web site. There will be three steps to the trader registration process:

Acceptance of various terms governing access to and use of PAM, the principal of which is recognition that PAM is a prototype and that the registrant is agreeing to participate in the test of this prototype.

Selection of a username and password by the registrant.

Deposit of funds into the registrant’s PAM trading account. On-line training will begin for registered traders on September 1, 2003. Live trading will begin on October 1, 2003.

As a means of ensuring the smooth and efficient start of live operations, registration will be limited initially to 1,000 traders. As system operations are tuned to the trading load, this limit will be increased. By January 1, 2004, the limit will be raised to at least 10,000 traders.

During this first phase, we appreciate input from prospective PAM traders. These comments will assist in development of the interface as well as general information about PAM. More information and details will be added to the site in the next few weeks, however, we welcome hearing your thoughts and interest through the button below.

The amount it will cost to get involved is not revealed, but I'm guessing not every Tom, Dick and Harry will have the funds to play on this market.

I wonder why Vegas isn't running this racket?

I thought this whole thing might just be a set-up to track terrorists and rogue states who may have designs in playing this market and making the predictions come true. If this clause is accurate, I would say this is a very stupid and potentially dangerous exercise.

It seems that most of you guys don't "get it". This project is extremely good at identifying below-the-radar terrorist activities, but it has nothing to do with the people actually playing the game, hence why the identities are irrelevant. The players are required to generate a good model of the information dynamics behind the gameplay.

The mathematics is pretty complex, but this "game" allows a very sophisticated traffic analysis of information that can provide the DoD with the ability to identify "hotspots" that are not directly observable. It sounds a bit weird, but it means that they can use this information to identify terrorist plots even if none of the players of the game are specifically aware of a terrorist plot. For it to work reasonably well, they need to allow the general population to play anonymously so that they don't inadvertently bias the model, which is also why the DoD personnel can't play. They need a really nice statistical baseline from the general population.

I happen to be acquainted with the guy who originally came up with this idea, which is actually many years old. He is an economist with very savvy math skills, and definitely one of the smarter humans walking the planet at the moment.

What you are looking at is the DoD using extremely advanced mathematics that is capable of identifying terrorists even if the terrorists don't play the game and hide themselves very well from the general population. You just have to recognize it as yet another example of wicked cool technology coming out of the DoD to give the USA an edge against everyone else. The people against this are clueless, but I don't think it has been explained very well (and a REAL explanation is fairly esoteric).

This isn't exactly the comical monument to bureaucratic idiocy that Drudge thinks it is.

It stems from research in the Economics Department at George Mason University.

More:

http://www.nytimes.com/2003/05/08/business/08SCEN.html?ex=1053400493&ei=1&en=45f7f11e2d1f470c

A Market Approach to Politics

May 8, 2003, New York Times, C2
By HAL R. VARIAN

Most political questions involve a combination of facts and values.

One example might be: Does global warming exist and, if so, what should we do about it? The first question is about facts; the second is about values.

Or consider a narrower economic question: What would be the impact on tax revenue of a cut in the dividend tax rate, and should we enact such a cut? There is presumably a factual answer to the first question, while the second depends on the value one puts on who gains and who loses from such a tax.

There is no shortage of experts who will opine on the
impact of global warming or dividend tax cuts, but it is
often difficult for a nonexpert to evaluate their
judgments.

Whom should you believe? How can a decision maker - or a
voter - appropriately weigh all those expert opinions?

Economists believe financial markets do a pretty good job
of aggregating information in part because they offer
strong incentives to those who make good predictions.
Prices of oil futures contracts predict future spot prices
well because traders who make better predictions can make a
lot of money.

So why not use financial markets to help aggregate
information about those matters of fact that are important
to public choice? This intriguing idea is examined in
detail in a paper by Robin Hanson, an economist at George
Mason University, called "Shall We Vote on Values, but Bet
on Beliefs?" (http://hanson.gmu.edu/ideafutures.html.)

The title says it all. There isn't much we can do about
values. Voting has many problems, but it seems to be better than lots of other ways to reach a social decision.

But beliefs are different. Markets may be able to aggregate expert opinion in ways that help voters form beliefs about the likely consequences of various decisions.

The Hanson approach is most appealing in cases of corporate governance. Think about hiring or firing a chief executive
- a huge decision for corporate boards.

In this case the "values" part is pretty easy: the board typically has a fiduciary responsibility to hire the candidate who will maximize the value of the corporation's shares.

The question is, which of the available candidates will
best accomplish this goal? Mr. Hanson proposes using
financial markets to answer this question.

The key is to create a derivative security whose value
depends on who becomes chief executive.

Suppose there are two candidates, Mr. Smith and Ms. Jones.
The board creates two stock options, one that will deliver
one share of company stock if Ms. Jones becomes chief executive, and one that will deliver one share if Mr. Smith gets the job. They also create two "money options"; one delivers one dollar if Mr. Smith becomes chief executive, while the other delivers one dollar if Ms. Jones does.

In a well-functioning speculative market, the Jones money option should sell for a price that is roughly equal to the probability that Ms. Jones will be chosen. The Jones stock option, on the other hand, should sell for the value of one share of stock if Ms. Jones becomes chief executive, times the probability that Ms. Jones will be chosen. The ratio of the stock option to the money option should therefore give the value of the company's stock if Ms. Jones is picked.

Every M.B.A. student is told to "make choices that maximize shareholder value." What could be a better way to do this than to let shareholders determine the value of each alternative directly?

The argument above is the simplest account, but one can
develop more sophisticated arguments that give essentially
the same outcome.

Once you get the idea, the possibilities are endless.
Suppose a company is trying to choose between ad agencies.
The board can simply create an option that pays off in
shares conditional on which one is chosen, along with the appropriate money options.

Given the increased liability corporate board members are facing, they should welcome ways to make sure their decisions are better aligned with shareholder views. Buying and selling shares is a lot easier than calling a proxy vote.

Mr. Hanson wants to go further and extend the idea to the political domain. Government agencies could define a measure of performance and let markets determine their actions.

Take central banks. Most economists think central banks
should care about both the unemployment rate and the
inflation rate. Market expectations about inflation can be estimated from existing financial securities, but what about unemployment?

Suppose the Fed creates a security that can be exchanged,
at some specific time in the future, for the unemployment
rate times $100. If the unemployment rate in December 2003
is 5 percent, then the "unemployment futures contract"
would be worth $5.

Now the Fed could issue options on this security. One
option would deliver one contract if the Fed sets a
short-term rate of 2 percent, another delivers one contract
if the Fed sets a short-term rate of 3 percent, along with
the appropriate money options that pay off depending on the decision.

All the board of governors now has to do is to see how the market values these two options and carry out whichever action the market recommends. Maybe Alan Greenspan isn't so irreplaceable after all.

Mr. Hanson speculates that one might even make explicitly political decisions - like setting the tax rate on dividends - by using such a mechanism. Economists would no doubt be active participants in such markets.

The Internet has made it easy to set up exotic futures
markets. For example, www.tradesports.com offers contracts
that pay off if statements like these become true: "Weapons
of mass destruction will be found in Iraq before May 31" or "Ruben Studdard wins American Pop Idol 2003." Both contracts are selling for about 50 cents right now, indicating that the market views them as even bets.

Perhaps the availability of such exotic securities will
lead to better decisions, in both foreign policy and
recording contracts.

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