Two years ago a DARPA project was canceled after some demagogues attacked a straw man which bore a superficial resemblance to the actual project. Now Robin Hanson (who had some involvement with the project) has written a defense of the straw man, i.e. an argument that futures markets might be of some value a predicting specific features of terrorist attacks (although not nearly as valuable as more natural uses of futures markets such as predicting the effects of changes in Homeland Security budgets on the harm done by terrorism).
He has a somewhat plausible argument that there is useful information out there that might be elicited by markets, particularly concerning the terrorist choice of method and targets. An important part of his argument is that in order to be useful, the markets might only need to distinguish one-in-a-thousand risks from one-in-a-million risks. One weakness in this argument is that it makes mildly optimistic assumptions about how reasonably people will respond to the information. There is clear evidence much spending that is advertised as defense against terrorism is spent on pork instead. Markets that provide a few bits of information about which targets need defending will raise the cost of that pork-barrel spending, but I can’t tell whether the effect will be enough to meet whatever threshold is needed to have some effect.
The section on moral hazard seems to contain a rather strange assumption about the default level of trader anonymity. The “reduced” level he talks about seems to be about as much as the U.S. government would allow. It isn’t clear to me whether any anonymity helps make the prices more informative (does anyone know of empirical tests of this?). The optimal level of anonymity might vary from issue to issue according to what kind of trader has the best information.
The proposal to hide some prices is more difficult than it sounds (not to mention that it’s far from clear that the problems it would solve are real). Not only would the exchange need to delay notifying traders of the relevant trades, but it would need to delay notifying them of how the trades affected the traders’ cash/credit available for trading other futures. Which would often deter traders from trying to trade when prices are hidden (it’s also unclear whether the trades that would be deterred would add useful information). In addition, I expect many of the futures that would be traded would be about targets and/or methods covering some broad range of time; it’s unclear how to apply a condition about “attacks to occur within the next week” to those.
The proposals to deal with decision selection bias sound politically difficult to implement (unless maybe Futarchy has been substantially implemented). But there isn’t much risk to experimenting with them, and elected officials probably don’t have the attention span to understand the problem, so there probably isn’t much reason to worry about this.