As mentioned in class, prediction markets are a powerful tool for making conjectures about future events without the need for a panel of ‘experts.’ By aggregating predictions from large amounts of people, their accuracy can actually surpass that of experts.  Sources like the Iowa Electronic Markets and Hollywood Stock Exchange provide investors with opportunities to buy event futures based on things like presidential elections and the success of films.  Scott Sumner and Aaron Jackson of the department of economics at Bentley College suggest that prediction markets can be highly effective in guiding global warming policy in the following paper: http://web.bentley.edu/empl/j/ajackson/GWexternalSep2008.doc

In their discussion, they also bring up the notion of a ‘bubble,’ when the price in a particular market rapidly grows past its underlying value.  The cause for this phenomenon may very well be another topic discussed in class, information cascades and group behavior. It is easy to see how a relatively small number of investors can push a market past the tipping point and start a cascade.  As investors rapidly start purchasing shares within a particular market, others become enticed to do the same, regardless of any prior beliefs or current information about the market.  However, eventually the bubble pops, as was the case with the internet boom in the 1990s or more recently, the housing bubble.

In order for global warming prediction markets to work effectively, bubbles are to be avoided.  This can be done by ensuring that a large heterogeneous group participates in the market, which the creators of the idea envision to be government subsidized.  Purchasing long term derivatives based on greenhouse gas levels and global temperature, private investors can make accurate predictions that influence public policy.  Among the possibilities of variables to predict are future global temperatures, and the correlation between C02 emissions and rising temperature.  Using higher precision measuring devices to keep track of the variables that the market is based on, perhaps the contracts could be reduced to shorter time periods than the proposed 10 years.  This would reduce the need for government subsidization and allow this potentially effective market to be put in place even sooner.  Altogether, it seems a logical solution to a divisive policy issue, and implementing the market would be a worthwhile effort in creating economically efficient global warming policy.