Environmental Prediction Markets

Abstract

This chapter explores the use of prediction markets to generate, collect, and process information relating to a variety of environmental problems. Prediction markets, artificially constructed markets for contracts for contingent payoffs, have been used to generate projections of future conditions and outcomes in a variety of different settings. Prediction markets provide incentives for individuals to bring private and decentralized information into the marketplace through trading. This chapter proposes that prediction markets could be applied to a number of environmental problems that suffer from poor information pertaining to the causes and severities of the problems or pertaining to solutions to the problems. The general form of the proposal is a two-part instrument consisting of (1) a unitary environmental tax that is indexed to the amount of environmental harm, and (2) a cap-and-trade system of permits to pollute in the future that can be redeemed in lieu of paying the tax. The amount of the tax would be indexed each year to one or more non-manipulable environmental conditions reflecting the degree of environmental harm. This cap-and-trade system is the prediction market, and indexed tax is the measurement of the future conditions for which predictions are needed. The tradable permits to emit in the future are essentially unitary exemptions from the future environmental tax, and prices for these permits should largely reflect market expectations of the future tax level. By linking the price of permits to the future tax, and by linking the future tax to future environmental conditions, this instrument solicits and processes information and expectations of future environmental conditions.