July 21, 2005
Irrational Love of John Roberts
Posted by Dave Hoffman

More on the virtual market problem.

Larry Ribstein ["Blogger B-E?"] over at Ideoblog suggests that unregulated trading markets are likely to be more accurate than regulated capital markets because they permit insider trading.  He notes  a problem with this hypothesis -- manipulation by decisionmakers -- although the real danger would seem to be destruction of confidence in the market itself.  I disagree somewhat with Larry here.   It seems to me that if you are evaluating the relative strength of experts and traders in predicting a nominee, believing there is inside information would make me more likely to rely on certain expert's opinions. 

  • There are two groups of possible tippees here: political hacks analysts; and legal gurus analysts.  Neither group is well incented to trade on inside information - both reap vastly more utiles by publicizing what they know on whatever medium is closest to hand.   
  • Experts, on the other hand, are chosen to appear on T.V. largely because they are perceived to have an inside track to the White House (related to Point 1) and are - at least in theory - retained because they are successful at demonstrating that conduit. 
  • Thus, if inside information exists, it ought to be passed to the public quickly - and if you are watching the right expert, you will learn when the market does (and before it reacts, given those markets' lack of liquidity).

However, I don't think there was any tradeable information on this nomination.  The relevant decision makers (not the President, the actual folks picking the short list) are already regulated by anti-leaking norms (indeed, the deterrent effects of such norms, given likelihood of enforcement and harm, may be higher than the under-enforced insider trading laws). 

The reason to rely on trading markets rather than experts in this limited arena is not because such markets effectively uncover unknown inside information.  It is because the experts who we might otherwise rely on are biased, unable to quickly abandon their "favorite horse" in response to new publicly available news, and because it I think it not worth my time to identify which experts I trust in advance. [Full disclosure: I almost never watch news on T.V., and caught none of the pre-nomination speculation there.]

Christine's post below about the trial of Enron executives on securities charges reminds me of one additional point about Tradesports that I neglected to make in yesterday's post.  When singing to praises of such markets, it is important to remember the problem of systematically irrational market results.  [For a summary of this problem, see here.  Don Langevoort's article here is also quite lucid.]  With respect to the trading markets for the Supreme Court nomination, liquidity problems (again!) make such concerns especially worth thinking about.  For example, in a world where we judge folks based on their looks, the "young and extremely handsome" Roberts, the fifth hottest federal judge according to some, could have have been irrationally overpriced.  Even if not,there is certainly evidence of herding by investors earlier in the day of the announcement. 

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