InTrade roundup

Robert Wilbin at Overcoming Bias has a great summary of how the InTrade price divergence lasted as long as it did.

Why was this possible? I don’t have a good answer, but I can suggest one possibility. Some noteworthy aspects of the situation are:

• Americans can’t deposit money into Intrade using credit and debit cards – they have to use bank transfers.
• Bank transfers take at least two days to arrive and cost at least $20.
• Everyone else can choose between cards and bank transfers.
• Cards are instantaneous and free (if denominated in US dollars anyway) but have a $2,000 deposit limit in the first month, and $5,000 thereafter.
• It takes at least a day, probably two, to open a new Intrade account and have it approved.
• There are other significant barriers to entry – knowing about the issue, learning about the fees, opening an account with another betting agency and finally having the time and confidence to correctly place the hedge.
• Intrade seems very widely covered by the US media.

Once someone started doing this, it would take at least two days, probably three, for a wealthy or ambitious person to respond by wiring in enough money to bet against them. In the meantime they would have to hope that the manipulation persisted long enough for them to profit from it. Until then, people outside the USA would be limited to putting at most $2000 or $5000 into their accounts, which is not much, and barely worth the effort for someone with the required skill. So someone could plan to do this over the last few days of the election without facing much resistance.

The volume yesterday on Obama’s Intrade shares was about 600,000. If all of those trades involved one person, who was losing 10 percentage points on each share, they would have blown $600,000 to keep Obama’s odds down. The volume over the previous three weeks is hard to read from Intrade’s graphs, but looks to be about the same again. So a single cunning person willing to lose $1 million could have singlehandedly driven the price difference if they wanted to influence perceptions of the race and encourage voter turnout. Out of the $6 billion spent on the election so far, that’s not a big investment. Intrade will face this problem until they make it easier for wolves to fund their accounts and go out hunting sheep. [emphasis added, strong agreement]

Weaknesses of this theory are:

• Why didn’t manipulation over the previous three weeks prompt someone to move a large sum onto Intrade to take advantage of this?
• Why haven’t wealthy Obama supporters attempted the same trick?

Back in 2008 we saw something similar; we later found out it was somebody hedging against political risk [darned if I can find the link now though]. If your company's fortunes are highly sensitive to political risk, you might well want to lay that risk off at InTrade. I don't know if that's what happened this time around; any company doing it only by trading at InTrade is throwing money away when it generates that gap in prices across markets. But fiddling around between InTrade and BetFair might be rats and mice for somebody with high opportunity costs of time. Counting against that theory: the price support mechanism lasted only until the polls closed in Colorado - the last of the swing states.

An InTrade heavy trader reckoned [a couple days prior to the election] it was a lot of small starry-eyed Romney supporters, but why wouldn't there have been Obama-enthusiasts similarly willing to inflate prices on their side? The article is excellent though - read it [HT: @MikePMoffatt].

I strongly endorse Wilbin's conclusion: it has to be easier to get money into InTrade so that things like this can't persist.

Mike Moffatt at the Globe and Mail's Economy Lab also notes the price difference across markets, pointing to BetFair's tax on winning as part of the problem.

A problem for those who would argue in favour of the forecasting ability of markets is that the probability of Mr. Obama’s victory on prediction market BetFair was consistently ten points higher than on InTrade. This presents a problem – if forecasting models are accurate, should the two markets not be forecasting the same thing? Furthermore, if both markets were truly efficient than this difference should be arbitraged away. In theory you should have been able to buy Obama futures on InTrade and Romney futures on BetFair and make a profit no matter who won. In practice, however, this is made difficult through transaction costs and barriers to entry. In order to comply with U.S. law, InTrade cannot accept payments via US issued debit or credit cards, an inconvenience to American users. But given that hundreds of thousands of shares were being traded on InTrade and transaction costs are minimal, it is quite an efficient market. BetFair, on the other hand, charges significant credit card fees and taxes on winning, which greatly diminishes returns. These transaction costs make BetFair a far-from-efficient market, so this helps explain the discrepancy.

That was part of it, and it was more of it in the time leading up to the day of the election. But the price gap across markets went as high as twenty points - BetFair's trading fees are inconsequential relative to the gap. The fees make it harder to arbitrage, but I don't think that they strongly effect within-market efficiency at BetFair. The biggest problem is the difficulty of getting money into InTrade. BetFair's tax on winnings lets small price differences across markets persist. InTrade's barriers to entry allow massive price differences to persist.

Last night's election reminded me too of a bit of fun on the Iowa Election Markets in 2000. I was trading pretty heavily there, mostly running minor arbitrages where the sum of bids diverged from $1 across markets. But I'd read the prospectus for the _WTA [Winner-Take-All] markets and a lot of folks hadn't. Winner, for IEM, meant "whoever is reported in the New York Times as having received the largest share of total votes" [my paraphrase from memory], not who won the election. In 2000, those differed. And if IEM's servers hadn't crashed, I'd have been able to execute a very large trade buying Al Gore at $0.02. I remembered that not only because it briefly looked like there was a chance that Romney could take the popular vote while losing the election, but also because iPredict's servers crashed while I was trying to back out of some of my short Obama position there [very long Obama at InTrade, very short at BetFair and iPredict]. The iPredict server crash didn't really cost me much - my position there was just about worthless. The IEM crash... that was disappointing.

My prior posts in this series:

• Barriers to Arbitrage
• Documenting the Arbitrage
• Final arbitrage position statement

I've just made my application to get my money out of InTrade, incurring a $20 wire transfer fee. Will report on the final net once everything's converted back to $NZ and all bank fees are paid.

It's been a bit of fun. The posts have been picked up on the twitter feeds running in the sidebar for FiveThirtyEight at the New York Times, so it's been fun getting traffic from there, as well as from Reddit and from the Slate comments threads.