Morning roundup

The morning's worthies:

• iPredict's PredictIt gets another stay of execution
• Kainga Ora has been making great progress in streamlining builds. So long as they don't get burned down. Perhaps it would help if nearby owners could reasonably expect Kainga Ora's tenants to be better neighbours. It's the rare prominent cases that create reputations.
• Jason Sorens says that bad zoning leads to dysfunctional housing markets and high prices, leading to bad ideas about how to fix the problem. A variant on Caplan's Idea Trap.
• Problems that wouldn't exist under proper road pricing and if debt for new roads could be backed by road-user revenues.
• I wish for a world in which Andrew Leigh were a Labour MP rather than a Labor MP. 
• Resale price maintenance. It is still fun to think through the conditions under which it's efficiency-enhancing substitute for vertical integration or otherwise efficient rather than potential indication of cartel-type mechanisms. The typical presumption is the latter, but it isn't necessarily the case. 
• ComCom price regulation of the proposed 3-waters entities will follow standard drill utility regulation. EnergyNews rightly points out that prohibitions on water suppliers earning a profit (remember that standard state-owned enterprises and council-owned enterprises can!) will "limit the extent to which profit can reward and incentivise efficiency and innovation". 
• NZ mayors pushing for city deals. Seems antithetical to Labour's current centralising DNA. Maybe some future better government will dust off the report we'd written back in 2015.

Missing iPredict

Sam Sachdeva's piece on Vic Uni's grilling at CFTC makes me miss iPredict and lament that the Vogons are everywhere.

CFTC argues that Vic Uni ceded effective control of the market to Aristotle, the company contracted to handle AML and payment processing, and that some of its contracts went beyond the scope of the no-action letter. It didn't like contracts on the number of Trump tweets, or on whether Hunter Biden would be charged. 

It's a shame. Prediction markets make the world a better place. And it's looking likely that we'll lose another one. 

The Sachedeva piece is currently gated, but may ungate in a few days by pulling the /pro from the URL.

The Vogons Return

In 2015, New Zealand's Vogons killed iPredict.

Money laundering was implausible, but considered too great a risk.

Today, the CFTC announced its withdrawal of its no-action letter for PredictIt, the US-facing site that Vic Uni maintained after iPredict went down. They haven't noted which of the conditions of the no-action letter was violated. I don't trade on PredictIt; not straightforward for Kiwis to do so. So I've no insights.

It's just a shame. 

PredictIt

PredictIt runs a pile of markets on the American Presidency, among other things. Here are some good ones for America-watchers:

• Trump to be President at year-end 2017 (currently 76%)
• Trump to be President at year-end 2018 (currently 66%)
• Will Trump be impeached in 2017? (currently 21%)
• Hillary to face charges in 2017 (21%)

The full set of US Politics predictions is here. PredictIt is the US-facing prediction market built by the iPredict team at Victoria University, here in Wellington, to serve American traders. Kiwis cannot trade there. We would have been able to trade on it at iPredict, but we no longer have iPredict.

Vogons

Ben Moore's received a response to his OIA request asking the government why they killed iPredict. Reading it is a bit surreal. 

• In September 2013, Chapman Tripp applied for exemption from the AML regulations. At page 12 of their submission, paragraphs 52-53, they rightly note that iPredict is tiny and that compliance burdens for the tiny accounts set up at iPredict would dissuade trader entry. 
• In October 2013, the Financial Markets Authority worried that because iPredict doesn't verify trader identities, there is risk that a single person could avoid the deposit limits by establishing multiple accounts. 
• FMA is there correct: it would be possible for somebody to set up multiple accounts if they were sneaky about it. But the current combined portfolio value of the top 100 traders at iPredict is just under $200,000. Fifty-four accounts have value in excess of $1000. I don't see any hovering under the $10k limit. And while there would have been substantial withdrawals since Simon Bridges's decision, the net worth rankings have been around this kind of order for a while. You need to add up the portfolios of 100 traders to get to about a quarter of the median Auckland house price. 
• In December 2014, an anonymous Policy Advisor in the Criminal Law Team at MoJ made a big deal of that the trader earning the highest ROI at iPredict had very very high returns, and that that analyst believed that this raised specific money laundering / terrorism financing risk. 
• It's worth noting too, though, that that high ROI trader doesn't show up in the top 100 ranking by net worth. Maybe the trader's just really great and keeps withdrawing, but the trader's account is worth less than $430 currently. Scary.
• MoJ also asks FMA whether iPredict should have to report whenever it becomes aware of any insider trading or "other forms of market manipulation", with requirements to submit STRs. 
• In June 2015, FMA said iPredict should be pretty much compliant were they to identify traders so traders couldn't open multiple accounts, and that they should do that rather than be granted an exemption. 
• 15 June 2015 MoJ asks iPredict a few clarifying questions, but provides zero signal to iPredict that they might need to identify traders. 
• 26 June, iPredict notes that there have been 3 instances of traders having more than one user accounts. Two of these were errors, and the third was deliberate. In the latter case, the account was shut down and the person was prohibited from iPredict.
• iPredict also notes that their systems only do automated withdrawals into NZ bank accounts, and that they have had one instance in the prior 6 months of an account's closure requiring an international bank transfer. 
• 12 August 2015 MoJ and FMA note that iPredict "has been designated to the DIA as the FMA has reached a view that it should not be within our supervision". This rather confuses me as iPredict's trading status is an exempt futures exchange. That they came under those regs rather than DIA's gambling purview was of some consternation to DIA when iPredict was set up as I understand things. 
• 1 September 2015: they decline the exemption
• Bridges then sends a letter to English's office, among others, notifying them that Predictions Clearing Limited had been denied an exemption. It is interesting that he did not let his Cabinet colleagues know that PCL is the clearinghouse for deposits to iPredict. I wonder whether his Cabinet colleagues were surprised that he wound up killing iPredict. He also sends a letter to iPredict's lawyers, denying the exemption, and suggesting they talk with the FMA about what they need to come into AML/CFT compliance.
• On 26 November, an anonymous boffin notes surprise that iPredict decided to shut down "without discussing this with anyone", noting that "the normal process after a declined application is for the applicant to contact the supervisor (FMA) to confirm what the obligations are under the Act." Perhaps true of for-profit entities. But that this surprised them suggests they never had any real clue about iPredict in the first place.

If iPredict could open new contracts, an interesting one would be:

"Pays $1 if the total value of bureaucracy staff time spent assessing iPredict's AML compliance exceeded the total combined value of all iPredict accounts."

I'd be buying at $0.65.

NGDP Targeting and NGDP Futures

NZIER's Kirdan Lees has called for the RBNZ to shift to NGDP (nominal GDP) targeting.

Recall that, currently, the RBNZ is supposed to target CPI inflation, over the medium term. The last part is important as it lets RBNZ look through temporary shocks. So if there's some silly blip from oil prices or commodity prices, they can just keep look at what things will be like over some undefined future period. While that lets them get away with persistent outcomes well in excess of target (Bollard) or well under target (Wheeler), it also means that targeting isn't as inflexible as it might otherwise be. And inflation expectations have remained reasonably anchored, though they're now drifting down.

Currently, RBNZ can target future inflation rates in a few ways. There are plenty of surveys of future inflation expectations. There's also the price difference between inflation-indexed and standard bonds. For a while, RBNZ used iPredict inflation forecasts, or at least cited them in a Monetary Policy Statement, but those forecasts largely mirrored ones you could get out of the rather more thickly traded bond markets.

How would you target NGDP? You'd need some mechanism for forecasting future NGDP. Sure, RBNZ has the big DSGE models for it, the latest version of which has an acronym nowhere near as memorable as the Kiwi Inflation Targeting Technology (KITT). But there aren't market prices out there on NGDP.

This was the problem Scott Sumner was trying to solve when I chatted with him at a conference in Hong Kong last year. He needed a way of getting NGDP forecasts to prove that NGDP targeting could be done. If you can get accurate forecasts, then you can use that in your targeting. I told him about how great NZ's regulatory structures are and that he should get in touch with the good people at iPredict. And so he did, and so there's now a US-facing version of iPredict that has a US no-action letter letting Americans trade on NGDP futures contracts.

But Simon Bridges just killed the New Zealand version of iPredict. So we can't have NGDP futures. So if we want NGDP targeting, it's going to be a lot harder. Thanks, Simon.

Well, unless we can convince the Americans to let foreign New Zealanders trade on the US-facing side of the NZ-based prediction market.

What a stupid stupid state of affairs.

The New Zealand National Party. Underestimating the compliance costs their regulations impose on small firms since at least Muldoon, and still going strong.

Update: I've been having issues in which Disqus is not synching comments made via the mobile version of the site and I have not had a chance to figure out how to fix it. And I cannot easily answer comments left that way. Belisarius asks what I make of the NZIER proposal. I'd hit that question in 2011 when NZPA asked RBNZ for comment on NGDP targeting. Basically, NGDP targeting beats inflation targeting when there are supply shocks, but RBNZ's inflation targeting lets them look through a lot of supply shocks already. And Sumner's noted that it works best in large diversified economies as well. Does New Zealand count?

iPredict and the reign of the Vogons

The NBR asked me for comment on the iPredict decision. Here's what I sent through; much of it showed up in Campbell Gibson's piece.

In the Hitchhiker’s Guide to the Galaxy, only one species had the bureaucratic bloodymindedness necessary for seeing things through, no matter how stupid it was to apply the rules in particular cases, or how horrible the consequences: the Vogons.

iPredict is one of New Zealand’s beautiful things. Established at the University of Victoria at Wellington shortly before the 2008 election, it allows real-money trading on political event futures. If you wanted to know the odds that National would win the next election, that Winston Peters would be in the next coalition, or that Wellington might amalgamate, iPredict was the place to go. If you thought the prices were wrong, you could put your dollar vote in and turn a profit by adding your information into the mix.

While other countries never really managed to get these right, New Zealand’s pragmatism saw us through. The Gazetted iPredict regulation let the tiny non-profit operate under rules that were fit for purpose. In America, an unholy coalition of casino gambling interests and anti-gambling Senators worked to ensure that Americans couldn’t easily trade real-money contracts on political events. New Zealand knew better. I considered it an important part of our “Outside of the Asylum” status. While regulations in the rest of the world were dumb enough to prevent beautiful things, New Zealand knew better.

And oh but it was beautiful. Its prices were the best fair-odds around on political events. There was never a ton of money in it – the volume was too low. But because enough politics insiders enjoyed it for its own sake, the listed prices were sharp. At Canterbury, I had fun setting Honours projects based on its data.

New Zealand yesterday took a sharp jump out of the Outside of the Asylum when Simon Bridges decided that a tiny shoestring-budget outfit like iPredict had to comply with anti-money laundering regs that even the big banks found a really tough slog. I don’t know how much he tried to ease things in recognition of iPredict’s smaller scale, but regulatory costs that seem small to a Minister can be impossible for an outfit that was always on the edge of financial viability. And as for the odds that it could have been used for any kind of money laundering? Well, I'd have been shorting the relevant contract even at 5% odds.

In short, the decision is regulatory murder: Vogons crushing beautiful jewelled crabs, just because. I hope the decision can be rescinded.

I visited similar themes in a piece I wrote for the Dominion Post.

That all ended yesterday. On advice from the Ministry of Justice that it was possible that somebody might some day decide to launder money through iPredict, Simon Bridges killed it. iPredict always ran on the smell of an oily rag, subsidised by Victoria University at Wellington. It would never have been able to afford big-bank style Anti-Money Laundering regulations – or even slightly toned down versions. While Ministers and Ministries can glibly reckon that regulatory compliance costs won't be too high, banks have found the anti-money laundering regulations to be incredibly costly. iPredict did not stand a chance.

When iPredict was established, they deemed the money laundering risk so low that there would not be regulatory compliance issues unless either the Americans invaded, or communists were elected. They did not count on the current National government.

The Government has killed a thing of beauty to guard against a risk that would have been implausible as movie scenario. In doing so, they've ruined our best, and one of the world's best, sources of accurate information on the chances of events happening. Colleagues who attended the British High Commission's election night party for the UK election reported that they had iPredict up on the big screen as a way of keeping track of who was winning.

Simon Bridges's decision is incredibly disappointing. I hope he reconsiders it. And, perhaps, it is time to rethink the anti-money laundering regulations as a whole.

I know that the Americans have forced us into the AML regime under threat to basically make financial transactions impossible with American firms. But only Vogon bloody-mindedness can explain hitting iPredict as part of it.

And here's Scott Sumner lamenting what we've lost.

I doubt either the Ministry of Justice or Bridges knew, or cared, about what they were destroying.

When John Key gets around to forcing a referendum on changing the National Anthem, one of the four five options should be "Oh Freddled Gruntbuggly", set to an appropriate tune.

Manitoba envy

Despite massive need for flat-pack furniture following the earthquake, Christchurch didn't manage to get an Ikea.* And there's yet no Ikea anywhere in New Zealand.

Last month, Christchurch people got mad that a Wendy's wanted to serve beer.

Meanwhile, Winnipeg's Ikea serves beer and wine.

* Trading on the iPredict market on whether there would be a Christchurch Ikea went as high as 18%. But Simon Bridges said we can't have iPredict any more, so I suppose there can't be a contract on whether we'll ever get an Ikea. So we're as bad as Manitoba on the predictions-market front now.

Unless the Americans invade or we elect communists

Glenn Boyle, who helped set up iPredict, emails:

When we were setting iPredict up between 2005 and 2008, all the holdups were technological and financial, not regulatory.  Liam Mason and others at the Securities Commission were generally helpful and tried to eliminate roadblocks rather than put them in our way, and there certainly didn't seem to be any impediments thrown at us by ministers.

I recall the money laundering bogeyman coming up only once, and then only in jest.  I don't remember the exact wording, but it was something along the lines of "you'll probably get hit with money laundering charges if the Americans invade or we ever elect a communist government."  Ouch…

This wasn't taken seriously at the time though.  Looking back through all the various memos etc I prepared during the 3+ years iPredict was being set up, I can't find any reference to money laundering regulation at all.  I guess we were naive!

There seem to be more than a few people who reckon Lianne Dalziel did a far better job on this stuff under the prior Labour government than we've seen under National.

Kiwis trading on American futures

There will soon be NGDP futures markets in which traders can buy and sell contracts paying out based on American quarterly nominal GDP. Scott Sumner's long advocated these kinds of markets for macroeconomic forecasting and as target for the Federal Reserve: the Fed should be targeting something like a 5% growth rate.

But the markets won't be based in America. They'll be here in New Zealand, run by iPredict, with backing from fans of Sumner's work.

Why here and not America? Mostly because New Zealand is way cooler than America.

Prediction markets got their start in the US with Iowa's Electronic Market, which exists by virtue of a CFTC no-action letter that, while allowing the IEM's existence, also massively constrains what it can do.

New Zealand's iPredict operates under a saner regulatory structure here, in the Outside of the Asylum.

iPredict exists thanks to the foresight of the University of Victoria at Wellington. It was set up when Canterbury's Professor of Finance, Glenn Boyle, was at Vic, before he came to Canterbury. I'd put in a couple of failed Marsden grant proposals to start up something like it at Canterbury before Glenn came over. I didn't know he was pursuing the same goal. Glenn beat me to it because he didn't waste time asking Marsden for money for it, and because he knew other ways of getting it funded. Asking Marsden for money for anything risky and cool is a waste. He knew not to bother; I'd not been here long enough to know that. iPredict operates as an authorised futures dealer under the Financial Markets Authority.

So we'll have quarterly forecasts of American nominal GDP going forward for a few years.

Americans cannot trade on these markets. Why? iPredict, a small University outfit, would then be stuck dealing with American regulations that make it impossible for small foreign outfits to deal with Americans. As Scott puts it,

We have to exclude Americans because . . . well because America is no longer a free country.  More specifically there are two problems.  First, iPredict does much more than the Iowa Electronics Market, and hence doesn’t have their waver from the Feds.  And second, there are now incredibly burdensome “know thy customer” rules that America imposes on foreign financial firms dealing with US citizens.  A small entity like iPredict (run by the Victoria University of Wellington) obviously doesn’t have the funds to meet all these burdensome regulations.  Now when I travel around the world almost everyone I talk to in the financial area regards US citizens in roughly the same way they view the Ebola virus.  They see our government has being a sort of madhouse.

We're the outside of the asylum, so we can do cool things here. Inmates of the Asylum can visit, but we have to be careful in dealing with them.

I'm very happy to have been able to help out a bit in hooking Scott Sumner up with the good people at iPredict.

When you're in a think-tank, fun stuff like this, that would never hit your PBRF portfolio, is totally worth spending time on.

Prediction failures

The flat payoff curve problem hit iPredict's vote share markets.

A contract paying $0.01 for every percentage point National got was trading at $0.44 just prior to the election: far below National's outcome of 48%. At the same time, iPredict's contract paying $1 if National were to win more than 44% of the vote was trading well over $0.80. What gives? You can tell convoluted stories trying to rationalise it around improbable underlying probability distributions, but it was just flat payoff curves.

I owned 250 contract of Vote.National. I paid an average of $0.4376 for those contracts. I will gain just under 5 cents per contract, for a gain of $10.60. To get that almost eleven bucks, I had $109.40 locked up in those contracts for a year. Sure, a 10% return seems fine, but it's a pretty heavy carrying cost where the opportunity cost is contracts elsewhere providing greater return (and more risk).

If we look across the "Pays $1 if National gets over x%" contracts, we get a fair odds line of 46.5% prior to the election. A contract paying $1 if National did better than 46.5% was trading around $0.50 in the last couple days before the election. That's still much worse than National's eventual outcome, but not nearly as far out as the 44% used in the Herald's comparison. I'd been warning folks round the office for at least the last month not to trust the continuous contracts because of the flat payoff curve problem and to rely instead on the ranged $1 contracts.

Why were the latter so far out too? That will be a fun one for the iPredict crew to look at. The fair odds line on the Greens was between 13.5 and 14%; the Conservatives were pegged between 4.5 and 5%. I don't know whether people were hedging (then why not short PM.National instead of the vote markets?), or failed to adjust thoroughly for that young Green and Internet/Mana voters might disproportionately fail to turn out.

How did I do?

• Well over a year ago, I'd shorted ACT's winning an electoral seat. I hadn't cleared that short position after Seymour was nominated because the prices had moved to what seemed then a fair price: I don't trade to reverse past errors, only when prices currently look wrong. So I lost $26 there;
• Up $171 on PM.2014.National, trading whenever prices seemed to have over-reacted either way;
• Up $5.61 (so far) on Vote.2014.Nat, having bought at around the $0.42-0.44 range. I bought a pile at $0.4475 back in March when prices seemed offensively out of whack with the $1 contracts, but then gave up trying to bring some sense to that market;
• Up $5 shorting that Act would win 2 or 3 electoral seats;
• Up $5 shorting that Russell Norman would be the next finance minister;
• Up $76 shorting Labour, trading whenever the market seemed to have overshot on either side;
• Up $45 shorting that the Conservatives would cross 5%.
• I was up on trading on Internet Party contracts, but I'd closed out all those positions well before the election and so am not entirely sure how it all netted out.

But I lost a couple of side-bets. 

Back in January, I'd reckoned that an Internet Party could cross 5% if there were an Internet Party and if there were a big Snowden release in the middle of the election campaign. I bet a round or two of beers on it with one loyal reader of this blog. I no longer believed the Internet Party likely to cross 5% when Kim DotCom sabotaged the Snowden event by releasing an email that everyone but him believed to be a forgery, but that sure wasn't a condition of the bet. I also owe BK Drinkwater and KiwiPollGuy $20 each. 

Somebody arbitrage and fix please

I've been explaining to folks 'round the office why we might wish to pay more attention to iPredict's markets on who will be Prime Minister than to the vote share markets. And I thought I might share it with you.

National's back up over 70% in the PM.National contract. If National wins, that contract pays $1; if they lose, it pays $0. It dropped into the 60s last week during the publicity around the Hager book, but it's now back up.

But, if we look at the major party vote share markets, it's hard to see how National could possibly be 73% likely to win. National's predicted to get 43% of the vote; Labour and the Greens are predicted to get 43% of the vote; minor parties get 14%. While NZ First may be more likely to go into coalition with National, Internet/Mana isn't, and Conservatives' wasted votes, if they get 4.4%, disproportionately waste votes that otherwise would have gone to National.

There's a bit of a problem in all the vote share markets though. You can only bring so much money into iPredict at a go, and folks might there be liquidity constrained. The winner-take-all markets can then just be more interesting. The VS markets, paying off at a penny for every percentage point earned by the party in the election, give little chance of large gains or losses. You can sink a whole pile of money into that market to get maybe a cent or two's return on a 43-cent investment. It's not all that great. The PM markets provide a less certain return, as there's bigger chance of large losses if your expectation of the probability is wrong or if the wrong side of the weighted coin turns up, but the 70 cent investment either gets you a dollar or it gets you nothing.

How can we tell that it's the continuous payout structure? iPredict also has a market where the National Party vote share pays out in buckets: one contract pays $1 if the vote share is over 43% (and $0 otherwise), another at $1 if the vote share is over 43.5%, another for 44% and up, and so on through 49%.

In the vote share (continuous) market, you pay $0.43 for a contract giving you $0.01 for every percentage point of the National vote. In the vote share (discrete) market, at current prices, you would pay $0.90 for a contract paying out at $1 if National gets more than 43% of the Party Vote. You'd pay $0.83 for a contract paying $1 if National gets more than 44% of the Party Vote. You'd pay $0.67 for a contract paying $1 if National gets more than 45% of the Party Vote. You'd pay $0.59 for a contract paying $1 if National gets more than 46% of the Party Vote. 46.5% is at $0.55 and 47% is at $0.48. So the market, in those bucketed contracts, expects National to get between 46.5% and 47%; the parallel Labour ones have Labour getting between 28% and 29%. That's rather more consistent with a 70% chance of National's forming government.

But watch for Winston. NZ First is at 4.8% in the standard vote share market, but he's also odds-on to take more than 5.5% of the vote. The Conservatives only have a 29% chance of topping 5%.

Somebody with time ought to go in and fix things so there isn't free money sitting between the bucketed and continuous vote share markets.

DotMana

Trading on the Kim Dotcom Internet Party stocks over at iPredict, complicated enough ex ante, has gotten even more complicated.

Prior to this weekend's rumours of an alliance with the Mana Party, the so-simple contract paying out $0.10 for every 1% earned by the Internet Party was really this mess:

Here's what you're trading on, if you're buying this contract. 

• The probability that DotCom actually forms a party (which I'd reckoned at 80% prior to this);
• The probability that DotCom is serious about the tweet (75%?);
• The probability that the Internet Party could poll above 5% prior to the deadline (which I put at even odds IF we get substantial GCSB Snowden revelations during the campaign);
• The expected vote share on election day. This expected vote share is:
• Zero if either of {No party, serious * less than 5%} obtain
• The vote share conditional on polling above 5% and conditional on DotCom being serious.

So, what the hell should you pay for a contract that pays $0.10 for every 1% of the vote earned by the yet-to-be-formed Kim DotCom Internet Party?

Let's label a few terms and make a few guesses. 

• Pp is the probability that there is a Party, say 0.8.
• Ps is the probability that DotCom really would kill the party if it doesn't poll 5% prior to the election, say 0.75
• Vh is the expected vote share conditional on a poll result of 5% prior to the deadline
• This one's hard to ballpark. You could make an argument for pegging it lower than 5% because a single outlier poll could be sufficient for his going ahead. But I expect that the state of the world in which he can get a single >5% figure is the state of the world in which we've had substantial GCSB revelations affecting NZ; in that state of the world, I'd put even odds on 5%. And so I'll stick it at 5, or $0.50 in iPredict prices.
• Vl is the expected vote share conditional on no polling result of 5% prior to the deadline.
• I'll peg this at 0.5%. If he goes ahead despite no polling result above 5%, credibility's shot. And it's also the state of the world in which there's no substantial GCSB revelations. So $0.05 in iPredict prices.
• Pt is the probability that the Internet Party polls at least 5% prior to the deadline.
• I'll peg this at at even odds IF we get substantial GCSB revelations during the election campaign, and nil otherwise. Supposing even odds on substantial revelations, that gives us 25%.

The expected value of the contract is then:

Pp*[[Ps*[(Pt*Vh)+((1-Pt)*0)]+[(1-Ps)*[(Pt*Vh)+((1-Pt)*Vl)]]]

Using my rough ballpark estimates, that's then:

0.8*[[0.75*((0.25*$0.5)+0)]+[0.25*[0.25*$0.5+0.75*$0.05]]]

= 0.8*($0.09375+.25*$0.04375)

= 0.8*$0.1375

= $0.11

And so I've put in a bid for 50 units at $0.09. I also put in an ask of 50 units at $0.15.

Denote as Pm the likelihood of a merger with Mana. Denote as Ph the likelihood that Hone Harawira wins his seat in a world in which he's merged with DotCom. If there's a merger AND if Hone's seen as very likely to win his seat, I expect DotCom would void his promise to kill the party were it short of 5% - every vote would count for the Internet Party if it had a seat under MMP.

I'm not going to put up the equation this time. It's going to be just too messy. But the following will matter:

• Pp, the probability that there will be a party, is now 0.98 (I expect)
• The party's expected vote share varies substantially based on whether they're allied with Mana.
• With Mana:
• On the upside, people may have fewer worries about throwing away their vote, but they shouldn't have had that worry anyway given the promise to kill the party were it not polling less than 5%. So maybe they get a bit of an up-tick from the expectation that there won't be a wasted vote.
• On the downside, you get an internet freedom, anti-surveillance party that's merged with some fairly non-standard economic ideas, conspiracy theories, and assorted random-draw oddities. The Green Party already combines internet freedom, anti-surveillance, non-standard economic ideas, and a slightly different set of random-draw oddities. I'm not sure what niche the DotMana Party then seeks to fill. Maybe it has a bit more "stick it to the Man" appeal than do the establishment Greens, but are there really many voters in that space? 
• So, the whole Ps argument is going to change then: the Party goes ahead conditional on polling above 5% or on Hone's being likely to win Te Tai Tokerau. Note that his odds there dropped from 90% to 83% over the past week. So we then have a 17% chance that Hone loses his seat. 
• In this world, the contract is really trading on the vote share for the combined party, and not simply on the likelihood of the party's reaching 5%. 
• Without Mana:
• On the upside, we're mostly back to status-quo ex ante;
• On the downside, there's the substantial WTF?! effect on those who would have been supporters of the Internet Party. I'd expected that an Internet Party could do well by staying well out of stuff other than internet issues: they'd then provide a landing spot for anti-surveillance or pro-internet voters who weren't comfortable with the Greens and who didn't trust ACT's commitment to freedom on this issue.* An alliance with Hone Harawira doesn't particularly make him more appealing to folks in that group, or at least I'd bet against it. 
• In this state of the world, and absent his buying some other MP, we're back to the calculation I'd run before, albeit around a lower mean due to the WTF effect.
• I have no idea how to start assessing the likelihood of a merger with Mana. My priors on what Hone Harawira might do on any margin are pretty flat. And Pm will matter.

I'm not going to peg new fair odds lines here. The initial market reaction had Internet Party dropping from 0.9% to 0.7%, spiking up to 1.5%, dropping back to 0.7%, then rising again to 1%. But it's a very thin market. I would be setting some buy orders at $0.05 (0.5%) and some sell orders at $0.15 (1.5%). But I've low confidence in either estimate and, more importantly, the market's going to move a lot when a final announcement comes on the Mana merger. Such announcements seem to like to happen when I'm driving and unable to trade. And so I'm staying the heck out of the order book for now.



* Jaime Whyte is very much against the expansion in surveillance that came with the GCSB and TICS legislation. His predecessor, John Banks, or at least Banks's office, very much favoured it. Some in the ACT Party come from the Sensible Sentencing Trust wing; I'm not sure they've ever seen an expansion in the police or security apparatus that they didn't heartily endorse. They trust that the GCSB will Do The Right Thing; they view the current surveillance arrangements as fully consistent with liberalism. Whyte doesn't. But that all does make it harder for ACT to commit to what I'd view as a liberal policy on these issues.

DotCom bets: they just got more complicated.

iPredict has a contract that pays $0.10 for every 1% of the vote earned by the yet-to-be-formed Kim DotCom Internet Party. The contract's price then is the market's expectation of the party's vote share.

But not anymore.

If #InternetParty won't poll 5+% before ballot papers are printed we'll self destruct & put our weight behind a party adopting our policies.
— Kim Dotcom (@KimDotcom) February 10, 2014

We now have a ridiculously complicated contract. Here's what you're trading on, if you're buying this contract.

• The probability that DotCom actually forms a party (which I'd reckoned at 80% prior to this);
• The probability that DotCom is serious about the tweet (75%?);
• The probability that the Internet Party could poll above 5% prior to the deadline (which I put at even odds IF we get substantial GCSB Snowden revelations during the campaign);
• The expected vote share on election day. This expected vote share is:
• Zero if either of {No party, serious * less than 5%} obtain
• The vote share conditional on polling above 5% and conditional on DotCom being serious.

So, what the hell should you pay for a contract that pays $0.10 for every 1% of the vote earned by the yet-to-be-formed Kim DotCom Internet Party?

Let's label a few terms and make a few guesses. 

• Pp is the probability that there is a Party, say 0.8.
• Ps is the probability that DotCom really would kill the party if it doesn't poll 5% prior to the election, say 0.75
• Vh is the expected vote share conditional on a poll result of 5% prior to the deadline
• This one's hard to ballpark. You could make an argument for pegging it lower than 5% because a single outlier poll could be sufficient for his going ahead. But I expect that the state of the world in which he can get a single >5% figure is the state of the world in which we've had substantial GCSB revelations affecting NZ; in that state of the world, I'd put even odds on 5%. And so I'll stick it at 5, or $0.50 in iPredict prices.
• Vl is the expected vote share conditional on no polling result of 5% prior to the deadline.
• I'll peg this at 0.5%. If he goes ahead despite no polling result above 5%, credibility's shot. And it's also the state of the world in which there's no substantial GCSB revelations. So $0.05 in iPredict prices.
• Pt is the probability that the Internet Party polls at least 5% prior to the deadline.
• I'll peg this at at even odds IF we get substantial GCSB revelations during the election campaign, and nil otherwise. Supposing even odds on substantial revelations, that gives us 25%.

The expected value of the contract is then:

Pp*[[Ps*[(Pt*Vh)+((1-Pt)*0)]+[(1-Ps)*[(Pt*Vh)+((1-Pt)*Vl)]]]

Using my rough ballpark estimates, that's then:

0.8*[[0.75*((0.25*$0.5)+0)]+[0.25*[0.25*$0.5+0.75*$0.05]]]

= 0.8*($0.09375+.25*$0.04375)

= 0.8*$0.1375

= $0.11

And so I've put in a bid for 50 units at $0.09. I also put in an ask of 50 units at $0.15.

Party time

ACT is in search of a new leader. The liberal right may also be in search of a new party. These together make for interesting trading times at iPredict.

I've reckoned that a party on the right economically does best by being firmly liberal on social matters. Not only does that coincide with my own preferences, but it also provides strategic opportunity for such a party to go into coalition both with National and with Labour/Green. Economic liberalism is advanced in coalition with National while, hopefully, preventing backsliding on social issues; social liberalism is advanced in coalition with Green/Labour while, hopefully, mitigating some of the backsliding on economic issues.

ACT hasn't been terrible on social liberalism under Banks, but neither could they ever really be leading on that front. Banks is a social conservative who wound up being stuck leading a liberal(ish) party. I can't fault him for his performance in that role given the constraints. I was very happy when he supported Louisa Wall's gay marriage legislation; his speech in support of the legislation was very good. A lot of the time he had seemed to be playing the part of a liberal leader, representing values other than his own because it was his job to do it - which itself is something for which he should be commended. On the gay marriage bill, he genuinely seemed to have come around substantially.

What problems on social liberalism ACT has had under Banks have come less from Banks than from divisions within the party. ACT's support for the GCSB/TICS legislation seemed to reflect the true preferences of rather a few within the Party rather than being just a necessary part of a coalition agreement. I think ACT missed a really big opportunity. Even just working out a couple of achievable improvements to the legislation and pushing them publicly as civil liberties wins for ACT would have gone a long way to avoid alienating the civil libertarian wing of the party.

I ran the numbers on the 2008 NZES election data suggesting there was room for a properly liberal party, whether ACT or otherwise. I'll have to re-do that with the 2011 figures.

iPredict has a series of contracts up on the ACT leadership. There's been lots of movement in those contracts since they were launched this morning. It's currently looking like a two-way race between Jaime Whyte and David Seymour, with Whyte on $0.60 and Semour on $0.20. Seymour worked in John Banks' office before heading to work for the Frontier Center in Canada; Whyte has a background in journalism and management consulting. Both would be great, though I'd be surprised if the still rather youthful (ie younger than me, a category that keeps getting larger) Seymour were picked. I have 100 buy orders in on Whyte at $0.50; 100 sell orders on Seymour at $0.30. I expect that either of them would represent a welcome shift towards a more classically liberal party.

There's also an "Other to be the ACT Party leader" contract, which pays $1 minus the payouts on all the other leadership contracts. This makes it not simply an "other leader" contract, but also a contract that pays out in the event that the liberal wing of ACT decides they do better starting a new party and that the Party then folds before deciding on a new leader. I've 100 buy orders in on that one at $0.01.

Finally, there are separate contracts running on who will be ACT leader on nomination day. There's always some chance that the next leader will not be leader on nomination day, though it seems odd that Banks is there running at $0.05.

I love that we get real-money trading on these kinds of contracts pretty much immediately. Thanks, iPredict!

Update: Hooton suggests a summer's thinking over whether there should be a new party. [NBR gated].  There were a lot of conversations on the right after the 2011 result wondering whether the liberal wing of ACT ought just go off and set up its own party; obviously, that obviously didn't wind up happening. I doubt a new party can really launch while ACT is still around. Choice of dooms, really. ACT has a lot of baggage and problems, regardless of any new leader. But launching a new party is incredibly difficult. A relaunch and rebranding building on an existing seat and accompanying Parliamentary resources wouldn't be a good as a new party that had access to similar resources, but a new party wouldn't have those resources.

Chasing the Xenophobic Vote?

One piece of evidence perhaps consistent with that that Labour's "dey terk yer house" xenophobic housing policy was in pursuit of votes that otherwise go to NZ First: shortly after Shearer announced it, traders at iPredict downgraded Winston's chances of returning to Parliament.

It's hardly conclusive: it's a pretty thin market. But traders reckoned that Peter's chances of returning to Parliament dropped from about 85% to about 62% on Sunday, 28 July.

And here's the strange part. Q&A, the TVNZ Sunday newsmagazine programme on which Shearer made his announcement, airs at 8:50 a.m. I'm not sure at what time after 8:50 Shearer made his announcement, but the trading on NZ First started at 7:19 Sunday morning, when what looks like a single trader pushed Peters to a 30% chance of returning to Parliament. That returned to 68% later in the day, and since eroded to 54%. So either:

• iPredict's time stamps are a couple hours out;
• Somebody knew what Shearer was going to announce and predicted that it would hurt NZ First - that somebody would most likely be in Labour as the announcement only came on Q&A;
• Something else served as shock to NZ First prices early Sunday morning and that move then stuck, perhaps because of the Shearer announcement, perhaps because of something else.

I don't think iPredict's time stamps are out. I shorted one "NZ First not to be in Parliament after next election" share at 10:35 to check it, and it's reporting that that's the last trade time. So pick one of the other two. 

If somebody in the Labour camp put a few bucks against Peters in anticipation of Shearer's Q&A appearance, that would be interesting.

Thanks to @JohnnySharland for the pointer.

Spillage Markets

Australia, Australia, we love your political theatre, Australia, amen.

iPredict was a bit overloaded during the surprise Labor leadership vote yesterday - it probably saved me from losing money. But it's fun to see what the markets thought of the whole mess.

Recall that Simon Crean put himself up yesterday for Deputy Labor leader, expecting that Rudd would declare his candidacy for the leadership. Gillard announced there would be a leadership vote to be held at 4:30 Oz time, 6:30 PM NZ time. This came as a surprise, or at least my Twitter feed was filled with very surprised Australians all tweeting at #spill and #spillage. Note that this was to be, I believe, the third time that Rudd has tried ousting Gillard.

Labor's odds have been in the toilet for, well, ages. At iPredict, contracts paying $1 if Labor were to win were trading in the $0.15 - $0.22 range; for the couple days prior, they sat at 15%. Gillard's odds of surviving to be Labor leader on nomination declaration day were around 70% prior to the vote's being called - they'd eroded by about ten points over the prior fortnight.

When the markets saw there was to be a leadership vote, Labor's odds jumped as high as 30% while Gillard's odds of surviving to nomination day dropped below 10%.

Labor's odds stabilised around $0.17 afterwards, with Gillard now 88% likely to lead Labor into the next election.

The pictures:

When the markets thought Rudd would be coming back, Labor's odds of winning went up. After #spill failed, Labour's odds went back down.

I wouldn't necessarily interpret this as the markets saying that Gillard should have been turfed; you might want to keep a less popular leader through an election you're likely to lose to keep your options more open after the election.

Me? I'm hoping that, after a year of a very large majority Coalition government, Andrew Leigh becomes Labor leader. He then loses the next election but not by a lot. Instead, he gets a lot of new Labor talent in who gain experience. Then he wins the subsequent election. I don't think I'd pay more than $0.05 for that contract, but I can hope.

Syrian arbitrage? [UPDATED}

InTrade says there is about a 63% chance that Bashar al-Assad will no longer be the President of Syria for any reason (including death) before midnight ET 30 June 2013.

iPredict says there is a 57% chance that Bashar al-Assad will be President of Syria AND have effective control of the government and military at 12:01 am 1 July 2013 NZT.

UPDATE: I had read the contract Long Description but not the Judging Criteria at iPredict. The Judging Criteria includes this:

This contract will immediately pay $0 if mainstream media reports say Bashar al-Assad has lost effective control of the Syrian Government or military, or words to that effect. For example, mainstream media reports that Bashar al-Assad has fled the country, or is on the run, or has gone into hiding, or has been overthrown, or has been imprisoned or arrested, will cause this contract to immediately close at $0.

And so the arbitrage opportunity below is much stronger: it only then fails to be arbitrage if al-Assad loses power exactly at midnight. Original post follows below, but do note that this error exists; the case for an arbitrage play consequently is much stronger.

---

The iPredict blog poked me wondering if this is an arbitrage opportunity for clever traders. And while I've taken a short position at iPredict, it isn't pure arbitrage. Imagine that the rebels over-run Damascus in April and take the government temporarily before al-Assad's forces come back to regain control in June. In that case, both markets pay out at $1: he would no longer have been President of Syria for a brief period, but he would be President as of 1 July.

Now I find the likelihood of that rather small: I would have thought that if opposition forces took effective control of the government, satisfying the InTrade rules, there wouldn't be more than, what, a 10% chance of al-Assad making it back in before 1 July. So that would justify a small price gap between the two markets.

I will continue to accumulate a short position at iPredict. Once the total value of the position at iPredict gets large enough, I will lay off some of that risk by sending money back into the InTrade market. It isn't a perfect arbitrage as it doesn't protect against the scenario above and I'm at risk if InTrade drops down to the iPredict price in the interim. But getting money out of InTrade takes a long time and standing accounts there draw a $5/month fee. If iPredict were thick enough to make a big play on this, then it could be worth heavily shorting both markets and taking a net short position on that al-Assad will not lose then regain power before July.

Shorting InTrade means paying $0.37 for a contract paying $1 if al-Assad is President on 30 June. Shorting iPredict means paying $0.43 for a contract paying $1 if al-Assad is not President on 1 July. You then pay $0.80 for a contract paying $1 UNLESS al-Assad loses and regains power. If you think the chances of that kind of reversal are around 10%, and if it takes about a 10 cent price gap to make an arbitrage play across the markets worth the hassle, then it's just barely worth making the play.

Twitter tells me al-Assad is now having fighter planes shoot rockets through a university dormatory.

InTrade also has just opened markets on the Oz election (HT: @Insteconomics); interesting arbitrage plays could come up with BetFair and iPredict. BetFair has the Coalition as most likely at about 72%; iPredict has the Coalition at 76%; InTrade has a spread between 64% and 80% for the Coalition. So no real arbitrage plays there yet, but worth watching.

Final Arbitrage Tally

The final tally for the InTrade arbitrage:

• Lost $NZD 636.77 at iPredict going long Romney. I should have lost $679.68, but backed out of some of my Romney position when things were looking clear. I'll count $679.68 as arbitrage loss; I did take on some minor risk in reversing some of my Romney position. 
• I made a series of credit card deposits to InTrade, ultimately reaching the $5000 US limit. My NZ card was charged $6209.96 for the USD$5000 deposit.
• I sent BetFair AUD$1000 to buy Romney; BNZ charged NZD$1286.51 to my card. I'll add $15 AUD to that to cover the money I there pulled from my standing account as BetFair charges 1.5% on deposits. So NZD $1305.81 lost at BetFair.
• Total costs then were NZD $8195.45
• InTrade wired me USD$7373.65 - my deposit, plus my winnings, less the $20 my account was in the red when I deposited, less a $20 bank wire fee charged by InTrade. This turned into NZD $8915.89, less a $15 wire charge from BNZ: $8900.89. 
• It took a fairly long time to get the money out of InTrade; I requested the withdrawal on the 7th of November; it arrived on the 19th of November. Fortunately, the credit card isn't due for a couple more days. 
• Somebody charged me an implicit currency exchange fee: Yahoo Finance cites rates of $0.818 for Monday, 19 November; $7373.65/$8915.89 = 0.827. This matters on these kinds of plays: had I been charged the interbank rate rather than somebody along the way taking a cent on the exchange rate, I'd have received $9014.24 instead of $8915.89. Because of the long lag between the withdrawal request and the relative volatility of the $NZD, you need some reasonable expected gains to be sure you don't lose out. Every one cent move in the $NZD costs about $100. If I'd only had expected arbitrage gains of $200, the realised amount could halve or increase by 50% ridiculously easily. 
• $8900.89 - $8195.45 = $705.44 net profit.
• UPDATE: Wow. I entirely forgot this one. I've a BNZ Platinum that gives me $1 in Airpoints Dollars for every $90 spent. So I get $91 in AirPoints dollars. 

I phoned IRD. They count this as winnings on betting and those aren't taxed. I did note that iPredict is a futures exchange for regulatory purposes in New Zealand; they didn't much care. The woman on the phone said that if I were trading on these every day so that it were more like income, then it would count. But one-offs like this are fine. I didn't ask how it would be treated if someone set up a Kiwisaver fund that accepted investments for trading on these markets.

Because it took almost two weeks to get my earnings out of InTrade, I was exposed to unhedged currency risk, making this not a pure arbitrage play.

Lesson: it's worth having standing accounts across a range of trading platforms. It takes far too long to set up an account to only do it when an opportunity comes up. Arbitrage gains are real, especially when a whale lands like the one that seemed to be trading at InTrade propping up Romney's price. But it takes a reasonably large price spread across markets. A one-cent spread covers the bank's exchange rate charge one-way; a two-cent spread covers two-way bank exchange rate charges; a three-cent spread covers the exchange charges plus half of BetFair's deposit fees; a four-cent spread leaves you a small amount of arbitrage gain but exposed to currency risk.

And be careful if you're financing this on the credit card: if the expected payout date plus a fortnight is after your credit card is due, your costs are going to be higher.

Final arbitrage position statement

InTrade will not allow me to deposit more than $5000 in a 30-day window, so I can't arbitrage any longer. My current positions:

• 739 shares on Obama at InTrade bought at USD$6.74 per share on average. 
• If Obama wins, I net USD$2389 less credit card exchange rate losses two ways.
• If Romney wins, I lose USD $5001 and credit card exchange rate losses one way.
• AUD$1000 on Romney at BetFair at 4.4.
• If Obama wins, I lose USD$1053 and credit card exchange rate losses one way.
• If Romney wins, I net USD$3335 less credit card exchange rate losses two ways.
• 2959 shares on Romney (mix long Romney short Obama) at iPredict, average price NZD$0.2297.
• If Obama wins, I lose USD$563
• If Romney wins, I gain USD$1849

On net, then, if Obama wins, I'm up $773. If Romney wins, I'm up $183. Less credit card exchange rate fees and realised currency risk in both cases. I expect Obama to win, so I don't mind having an unbalanced position. I'm currently cheering only for that the election be decisive and not go into endless recounts or Supreme Court challenges that push the payout until after my credit card comes due. If you're a voter in a swing state, I strongly encourage you to go with whatever everybody else seems to be doing.

I'd like to resist the temptation to play at range trading on iPredict during the day so I can get a clean final outcome, but I doubt I'll be able to.

Previously: Barriers to Arbitrage (why most folks may not be doing this); Documenting the Arbitrage.

In other news, it's fun to compare these two Twitter searches [ht @LyndonHood]:

• "if Obama wins New Zealand": about 19 people claiming they'd come here if Obama wins.
• "if Romney wins New Zealand": about 14 people claiming they'd come here if Romney wins.

In both states of the world, it's optimal to move to New Zealand. Tiebout gives you the only vote where you're guaranteed to win.