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pcm 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?
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.