Information Landmine

"The Americans keep telling us how successful their system is. Then they remind us not to stray too far from our hotel at night." - An un-named EU trade representative quoted during international trade talks in Denver, Colorado, 1997.

Wednesday, October 01, 2008

Prediction Markets Questions

I've been getting more and more interested in predictions markets of late. For those who aren't familiar with the idea (and, frankly, why would you?), a predictions market lets you buy and sell bets on whether a certain event is going to happen. Oversimplifying a bit, the idea is that this gets you a better prediction than just looking at bookies odds, because everyone is placing bets can also sell them. So anyone who has any useful information to bring to the topic can look at the odds, say that they're under/overvalued, buy/sell them, and make a profit if it turns out they were right and the market moves the way they were expecting. All very Friedrich Hayek.

Anyway, the point is that, just like other sorts of markets, there's potential for arbitrage for the same good on different markets. If I see great odds on something on market A, and shitty ones on market B, I can make myself a healthy, risk-free profit buying on A and selling on B, in just the same way that traders do in other markets like currency and shares. A happy side effect of this, so the theory goes, is that all the markets get more efficient in their predictions, because instead of having lots of little markets, you've got one big one.

Trouble is, it doesn't seem to work like that. People have been commenting for some time now on how Intrade, which tends to be the go-to market for political events, is out of line with the other major betting exchanges on the hardly-obscure matter of who's going to be the next president of the US. At the moment, by my back of a fag-pack calculations. You could buy (bet on) John McCain at Betfair

sell (bet against) him for the same amount on Intrade (NB for anyone tempted to try this, you'd have to have about twice your betfair bet to cover your position)

and make a tidy profit either way.

Now why would this be the case? Part of the explanation is that Americans can't trade on Betfair, whereas they do trade on Intrade. But all that really means is that this should be a way for savvy folk outside the US to make a killing on the price difference. Which isn't happening.

There is, in essence, still a big pile of free money between the two markets. Why might this be?

Well, Nate Silver noticed back in September that a lot of the shorting of Obama seemed to be happening in spikes - as though one trader or institution were gambling heavily on the Obama campaign getting somehow derailed. This, obviously, can give rise to all sorts of conspiracy minded thinking, especially as people also seemed to be buying stock in Hillary. Assassination market, anyone?

I'm not sure I buy (sorry) much of that, especially since it seems to have stopped now, but I wonder if there isn't another possibility. Towards the bottom of his article, Nate drops this little gem:

And if I were one of those Beltway pundits who thinks I can be hip by referring to Intrade, I would take a look at the gross inefficiencies in these markets and think better of it.

Now, if Intrade is considered to be accurate by campaign journos, what's to stop someone affiliated with the McCain campaign buying up his stock and shorting Obama? Might not sound like a good use of money for the campaign, but it's a pretty good way to get round campaign finance laws if you happen to have maxed out your donations. This works particularly well in so far as the media covers the horse-race ("McCain announced his healthcare policy and polls suggest it was well-received"), rather than the issues ("McCain's healthcare poilcy is pure bullshit and relies on made-up figures"). If you have stock in Halliburton feel your business would do better under a Republican administration, you might think of it as an investment.

More sinisterly, what if it actually is someone working for Dieblold with inside information that hasn't yet come to light?

The bottom line is that I don't have a clue what's happening, but if it is someone trying to get some momentum behind McCain by buoying up his chances on the fancy new predictions market, then arbitrage on this could bring a whole new meaning to the idea of ethical investment. I have duly taken a position.

Update: WSJ had an article to the effect that someone still messing around with it on the 2nd October, and it shows no sign of stopping:

They also point out that the fact that this happens at times when trading is slow suggests that this is someone trying to move the market, rather than someone with inside information.


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