In Paul Krugman’-s blog entry, Done, at 4:39pm (EDT) on March 21, 2010, he commented: “-OK, nothing is sure in this world. Intrade is still giving Obamacare a 2.2% chance of failing, …”-
He was talking about the InTrade market on Health Care Reform. In theory, the market price in such a derivative market should equal the expectation of the underlying event coming true. However, Paul Krugman (and many others) forgot one of the most basic assumptions of the market model! Transaction costs.
When the market price is over 95, InTrade charges a transaction fee of 3 cents per contract (real money). While market prices are quoted in percentages, the payoff for a winning ticket is $10 (real money). Therefore, the transaction fee is 0.3% of the winning payoff. In addition, InTrade charges 10 cents per contract on expiry (if you “-win”-). That’-s another 1.0%.
So, when the market was quoting 97.8% likelihood of the HCR bill passing before June 2010, this didn’-t really mean that there was a 2.2% chance of the bill not passing. A winning ticket would be subject to 1.3% transaction fees. The real likelihood of failure was 0.9% –- approximating the uncertainty that Obama would be “-hit by a bus”- before signing the bill into law.
No rational investor would wish to purchase a share for more than 98.7, given the transaction costs. In a sense, this is the market’-s “-100%”-. Interestingly, at 1:49pm GMT today (March 23), there are 695 bids at 99.1 and 413 asks at 99.2. Clearly, some traders are not subject to the full transaction fees at InTrade. More about that here.
[Cross-posted from Toronto Prediction Market Blog.]
Business Insider cites various InTrade probabilities.
PaddyPower is a bookmaker, not a prediction exchange. Hence, the Tiger Woods divorce cost odds are computed by an analyst, not by the market.
1. It is not the “-punters”- who have fabricated the odds, but a PaddyPower employee.
2. It is not a set of “-market odds”-, but a set of bookmaker odds.
3. The bookmaker analyst does not have access to any confidential contract. So, the PaddyPower press release is aimed at suckers in the media.
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Previously:
– the latest InTrade predictions
– Emile Servan-Schreiber’-s post on market arbitrage
I like BetFair and the BetFair people very much. I was the only blogger to talk up the BetFair starting price system and the BetFair brand-new bet-matching logic. But the other face of the coin is that 2 aspects of their model are rotten to the core.
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BetFair was created in 1999 and started off in 2000. Since that time, 2 major things arrived on the world scene. Number one, we have seen the emergence of the prediction market approach. Number two, the Web has taken our lives, and Google has become the dominant Internet search engine. Here are how these 2 major trends are affecting BetFair negatively.
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The British, who drive on the wrong side of the road, don’-t have the 2 most important keys of the future.
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BetFair is running markets on both who will be the next vice president and who will be nominated by the two parties.
As we’-ve discussed before in other contexts, one can divide two probabilities like these to obtain a conditional probability: e.g., if the Democrats put X on the ticket, they will win the general election Y% of the time (where Y = odds of X becoming VP/odds of X being nominated).
These markets are thin, so the conditional probabilities should be taken with a grain of salt. But they are interesting nonetheless:
The pattern I see here is that conditional probabilities are higher for fresh faces (Webb, Sebelius- and arguably Bayh and Richardson despite their longer tenure) than for the old guard (Clinton, Nunn, Biden).
Of course, these should be viewed as correlations, not necessarily causal effects. For example, two possible explanations are: 1) putting a fresh face on the ticket helps Obama, either because there is less baggage or less of a contrast in national-politics resume length, or 2) Obama will only pick an old guard candidate in the state of the world in which he needs to shore up a weakness (i.e., picking Clinton to end a civil war, or Nunn to add foreign policy experience).
On the GOP side:
Huckabee has the highest conditional probability, and Pawlenty and Jindal are noticeably lower. Interpreting this one is harder: it depends on what aspect of Huckabee one thinks the market is expecting to be appealing (religion, likeability, Southernness, selective economic populism).
Technical note: the bids and asks reported above are actual quotes scrapped this AM- the mids are (bid+ask)/2, rescaled to add to 100 across all candidates.
Steve Roman:
It’s good to see Intrade cited as authoritative but I don’t think the recession contracts have enough liquidity to accurately reflect the odds. Citing a contract price when there is only a small amount of liquidity is one issue the MSM does when the number may not be credible. Some others that come to mind:
1. Thinly traded contracts may not reflect true odds – For instance, the contract for the US entering a recession in 2008 is now trading at 31. A pundit may cite this as a 31% chance of the US entering a recession in 2008, but he would not note that there is a 10-point spread around that price, so that by trading one lot, the odds will change by 5 points up or down. It would be a meaningless move – or would it? In such a thin market it impossible to tell.
2. Contract rules are important – Will Larry Craig resign? Did a missile leave NK airspace? The contracts for these events were based on rules that could be interpreted to have the opposite meaning of what most people would assume they do.
Even with Intrade’s recession contracts the details are important. The contracts will pay off when there are two consecutive quarters of negative GDP growth. That’s easy to understand, but is only one definition of recession. In the US a recession starts when the NBER says it does, making it possible for the GDP definition and contract odds to show we are not in a recession as the NBER declares we are. Not a major issue, but one that should be disclosed.
3. Timeframe should be noted – US News is the latest violator of ignoring time frames when discussing price changes, http://www.usnews.com/blogs/capital-commerce/2007/10/16/recession-odds-continue-to-fall.html . When talking about price changes it is necessary to talk about the time period over which the changes occurred. Did the odds of a recession decline from 60% to 30% within the past week? The past month? Not citing a timeframe or including a chart means I have to go back to Intrade to check on my own.
Steve Roman’-s blog: Nasty Brutish And Tall
