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mattnewport comments on Arbitrage of prediction markets - Less Wrong
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I'd never really looked at Intrade before. It seems from a quick investigation that there's a fairly major problem for anyone who wants to arbitrage this particular market (the 2012 Republican Presidential Nominee market) which makes for a rather inefficient market.
I pointed out in another comment that unless you believe Ron Paul supporters are more prone to wishful thinking than others that the biases should cancel out. If you look at the prices currently it appears that everyone's supporters are prone to wishful thinking - the sum of all current market prices for all candidates is quite a bit over 100. It should be possible to arbitrage this by simply selling all the contracts. You get more than 100 coming in and never pay out more than 100.
Unfortunately it appears Intrade requires margin on the basis of your maximum possible loss and treats every bet in this market as independent! In other words if you sell against every candidate you have to meet a huge margin requirement even though you are not actually liable for more than a 100 payout in the worst case.
Am I missing something here or is this really the way Intrade works?
But what if the Constitution changed to allow co-presidents?
Not likely, but I thought I'd point out that I've been black-swanned on Intrade already. I bet on there being 50,000 swine flue cases by June 30, but then about a week before that deadline the CDC made a decision to stop updating its totals, pausing the count at a little under 50,000.
Even though the bet was written so that the CDC numbers were just being used as "best available", Intrade decided at that point that those numbers would define the bet. So even though all other counts settled on a number well above 50,000 by June 30, the CDC was considered official and I lost the bet.
Sum of bid prices is 135.5, sum of ask prices is 172.2. As there's no other option, true sum should be less than 100, and obviously more-than-100 figure is nonsense.
That's an even more obvious case of getting some money by correcting a prediction market, and again I don't see how to do it without significant collateral.
You can't do it at all; I've checked it out in previous cases. You have to be able to cover all possibilities and make a profit. So any combination that covers A and ~A will be more expensive to bet on than any return. No amount of leverage will correct this.
It appears to be possible in theory with the current 2012 Republican Presidential Nominee market. The current bids sum to quite a bit more than 100 so by selling contracts on every outcome you should receive more than 100 and you will never have to pay out more than 100 so you should have a guaranteed profit.
The problem is that the rules for this market say
which suggests to me that you would be required to put up margin to cover the possibility of losing every bet which is clearly not a possible outcome. That makes it impractical to take advantage of the arbitrage opportunity.
Liquidity might also be an issue in this case - you might not find buyers for all your contracts at the quoted market price.
You're correct about Intrade's requirement to front the money to cover your position in all cases until the contract ends or your sell it.
However:
That doesn't follow. Even if the bids sum to more than a hundred, you have put up the other fraction of $10 for all of those n contracts. With a lot of the bids very low, then in order to cover all possibilities, you have to put up over $9 on many, and so it looks like you will have to front more than $10*(n-1), making it a loss from the beginning.
Yes, I ran the numbers in several cases like this in the '08 election.
Aren't you just restating the margin problem? The reason this strategy is impractical to implement is that you have to put up a lot of money to cover the payout on every contract you sell, even though at most one of them will pay out. The fact that Intrade don't pay interest on deposits makes that a poor use of your money but you will get most of it back once the nominee is announced. You also get to keep the (100 + n) you got from selling the contracts and only pay out at most 100 leaving you with a profit of n.
Unless I'm misunderstanding something about the way Intrade works you will make a profit, but to do so you will have to tie up a relatively large amount of funds in a non-interest-paying Intrade account for the duration of the bets. With interest rates so low at the moment that's not such an issue as it might be under more normal interest rates.
Horrible. If you can get access to it - use Betfair. It's probably blocked in the states though.
Intrade usually takes into account the fact that they're mutually exclusive, and doesn't require additional margin for additional candidates (I haven't seen this documented anywhere, but it seemed to behave that way in the last election).
Still, Intrade's margin rules aren't as good as those of the big commodity futures exchanges. Interest rate futures have asymmetrical risk, but that doesn't distort prices because little margin is required and they're liquid enough that you can cut your losses before prices change too much.