Five Reasons the Prediction Market Critics Are Wrong.

New PM post excerpt below. Read the full post at Midasoracle

1. It really was an upset – As it has been pointed out elsewhere, the Clinton victory was a surprise to everyone....

2. Pundits/Critics are NOT traders...

3. PMs are not polls – This common mistake is exemplified by this quote from the Chicago Tribune, “The New Hampshire primary was a reminder that prediction markets, where bettors are putting money on the line, can have no more value than opinion polls, where participation costs nothing.” This critic missed the point and doesn’t realize he is comparing apples and oranges....

4. Regulations have hurt the accuracy and liquidity of PMs – The inconvenience of opening a trading account at Intrade has excluded many Americans from participating....

5. “Serious people who study or work with these markets are not in the ‘markets are magic’ camp” – Prediction markets are like other financial markets: fat tails, black swans, bubbles, “manipulations” etc. ...

2008 Presidential Nominee - Search vs Price Trend

Gore Beating Obama in Nobel Prize Surge

Political Strategy and Prediction Markets

Strategists who want to know when a strategy is effective should pay attention to the market. Here is one losing strategy Edwards should drop:

According to Intrade.com, every time the Edwards presidential campaign (via Elizabeth Edwards) tries to engage Coulter in a catfight, his price plummets. His lowest point was after Elizabeth Edwards' "surprise" call-in to Hardball with Chris Matthews in June 2007.

Mr. Giuliani might want to check out intrade before he takes anymore calls mid-speech.

Betting on 2008 Russian Elections

Interesting article from the St. Petersburg Times:

But Shans has been careful in offering bets not on election results, but on changes in the popularity ratings of individual politicians and parties.

“And we will stop taking bets when the election campaigns officially begin,” said Oleg Zhuravsky, head of Shans and executive director of the National Association of Bookmakers.

…

Ireland’s Intrade offers contracts that will pay off 100 monetary units — the choice of currency is up to the gambler — if a certain figure becomes president.

Oddly enough, Putin, who is barred constitutionally from running for a third consecutive term, has topped the action, with 128 contracts sold for 11.5 units, meaning, for example, that an $11.50 bet returns $100.

007 Finance - NYT on Intrade

An article about off-beat investments in the NYT mentions Intrades political contracts:

For that matter, why not go to Intrade, an online betting site, where you can hedge the 2008 presidential election? If you’re a Democrat, try betting Republican, so that if the vote doesn’t go your way, you can take solace in the cash you make on election night.

This is very similar to an idea on The Economist blog:

Go to Tradesports (or the officemate you like to argue politics with) and lay a wager against your party. If they lose, your sorrow will be mitigated by the burst of dopamine which accompanies a sudden realisation that you are now several hundred quid to the better.

Mark Warner Officially Withdraws from Race

“I have decided not to run for President.”




His contract collapsed on the announcement to its current .6 level. The biggest DEM gainer was Edwards who picked up nearly 6 points (his contract now trades at 13), followed by Clinton who picked up 2. Clinton is by far the favorite for the 2008 Dem Nominee with her contract at 48 and looking like a good short when the time is right. The next closest nominee is Gore who is trading at 17.

Will Hillary Drop Out of the Race? Who Benefits?

http://www.timesonline.co.uk/article/0,,2089-2340352,00.html

FRIENDS of Hillary Clinton have been whispering the unthinkable. Despite her status as the runaway frontrunner for the 2008 Democratic nomination for president, some of her closest advisers say she might opt out of the White House race and seek to lead her party in the Senate.

Tradesports 2008 GOP Contracts and Roe vs Wade

http://elcapitan.redstate.com/story/2006/4/19/25046/0362

This is a unique application of the political futures on Tradesports. This blogger uses the chance that a candidate will be anti-Roe and their anticipated odds of a winning the presidency, to calculate the odds the next SCOTUS Nominee will be anti-Roe. His numbers may need a little work but still very interesting stuff.

A Bi-Weekly Update on the 2008 Election Contracts

Undoubtedly these will get much more interesting as the event draws near. A two year float is huge, even with a margin account I wouldn’t touch these. This is site does a great job of tracking the contracts. HeavyM does not seem to trade but it is still a great page

Intrade Wrapup: 24 Months From Super Tuesday '08

The Problem With Long Dated News Futures

Some of the most interesting contracts available are the news events futures where you can bet on a certain event happening.

Will Iran be bombed by Israel or the US before March, 2007? Will bird flu be found in the US this year? These and other news contracts are available to trade on online and have the same form as the other available contracts. The contracts can trade between 0-100 and will have a value on expiration of either 0 or $10. So if the contract is trading at 50, the price will be $5 per contract. This also implies odds of 50% of the event occurring. The idea of news futures is an attractive one and not just for the fun of speculation.

It would be theoretically possible for businesses to use them to hedge against events that would effect them. Lets say a chemical manufacturer knew that it would have to install new safety equipment if a democrat was elected president in 2008. A great way to hedge would be by using the 2008 US Presidential Election Winner contract which offers Republican, Democrat and Independent (ha!) as choices to win. To protect themselves from the additional cost of installing new equipment they could buy democrat futures. If a democrat was elected the additional costs would be offset by the gains on the contract. Taking it a step further new futures can be used to hedge against events that firms would otherwise have no protection for. A Cat 5 in NYC, a terrorist attack in LA, etc. All of these risks could be quantified and offset using an online futures market.

Unfortunately, that reality is far away from occurring. From the view of a market participant their are several difficulties that make the market as it stands unattractive for speculators and legitimate hedgers.

1. Liquidity - None of the news event contracts available so far have the depth and liquidity to be more than speculators' toys. While sporting events contracts attract many participants, news events have not received anywhere near enough traders to be serious for pros. An order of 50 contracts can move the market several points, and even if you have a good hunch or inside info there isn't enough available to make serious money.

Its a chicken and egg issue, until the contracts can attract enough traders to have a continuous, liquid market the serious traders won't touch it. But until the serious traders get involved there won't be enough depth to attract new participants. This issue, I believe, will cure itself, liquidity begets liquidity and this one just needs time.

2. Volatility - Let say you had the ultimate inside information, you knew that Iran was restarting it nuclear weapons program. Before that happened you bought as many Airstrike.Iran.Jun06 contracts as you could without moving the market. How many points would you have been able to make? Almost nothing. The market moved a total of 7 ticks from 11 to 18 (see chart), which translates to 70 cents per contract (ignoring trading fees). If you were long the entire market you would have a gain of less than $1,500 on paper and a huge problem with offsetting it.




The long dated news futures seem to move in similar ways. A gradual time decay with random spikes up on rumors. As soon as the market is satisfied there is no substance behind the rumors, the market quickly declines to its pre-spike price and resumes the time decay (see chart).



The issue is that the spikes aren't big enough to make the trading worth while and since the contracts don't move like options you can't get and extra "whip" from trading the long dated ones. So why not sell the contracts? That leads to our next issue.

3. Unattractive Margin Requirements - The way margin works on the account is that the funds that are set aside for each trade (and no longer available to make other trades until the position is closed) are based on a worst case scenario. So if I sell a 100 contracts at 30 for an event that closed in December, I have to set aside $700 for the entire year (if I hold till expy) for a chance to win $300. The funds are set aside for a long period of time, not earning income and only have limited gain. Why bother? Of course I could trade on margin but I would still need to have cash to cover swings in the account.

The combination of the above three make the market unattractive for serious speculators because it is so hard to make money. There are many opportunities in the market especially in shorter term economic numbers and news events close to expiration. For now, long dated news futures are just for fun.