Risk Markets And Politics

Saturday, October 18, 2008

Intrade offers an explanation of strange trading

Intrade has made a statement on the unusual trading that many have noted and alleged to be manipulative. The statement suggests that the price action is mostly attributable to a single firm, a hedger "using our markets in good faith and in the ordinary course of their business."

The first company that comes to mind is Centrist Messenger. Centrist is an interesting firm that re-sells political ad time and refunds sales to customers whose candidate loses. Centrist has stated publicly that it uses Intrade to hedge this exposure.* If Centrist had something to do with the unusual trading, it suggests that they sold more Obama than McCain ads, creating exposure to a GOP victory, resulting in McCain buys and Obama sales on Intrade. Why such a firm would be such urgent price-takers isn't fully explained.

Whether or not it was Centrist isn't important, but as these markets mature we should expect them to attract more hedging activity, and this might introduce persistent price distortions. Indeed it makes sense for people in the top tax bracket to be long Obama apart from considerations of his chances of victory. This is another uncomfortable subject that I've warned about in the past. When these markets become deeper and more widely available, the odds of the high-tax candidates might begin to show an upwards bias, a risk premium. Interestingly, Musto and Yilmaz predict that such markets will eventually lead to increased promises of redistribution by candidates. Talk about unintended consequences.

Intrade is doing the right thing here though, dealing with tough issues realistically and with as much transparency as possible. They provide valuable information, for free, even in places where they are not necessarily welcome. The depth of this information helps us to evaluate Intrade prices and have more confidence in them. Here is an example below, based on Obama's market over the past two weeks. Some have noted that the purported attacks occurred in hours where the market was unusually thin. This chart measures such price manipulability. The red line represents the ease of a downwards attack. It is the 100 x the amount of margin required to sweep the top fifteen bids divided by the difference between the highest bid and the fifteenth highest bid. (That is, how much the probability of an Obama victory can be moved by risking $100. Commissions are not taken into account but would of course would be vital.) The green line is the ease of an upwards attack. This is a very preliminary study and I will leave it to others to voice initial impressions. The fact that we can gauge to what extent traders are exercising market power is in itself important however.



* Technically another firm does the trading. Centrist is incorporated in the US, and the trading firm is incorporated in St. Kitts. Through this arrangement, Centrist cleverly avoids violating UIGEA.

3 Comments:

  • I'm interested how the Centrist Messenger avoids the UIGEA. Surely it is entering into an online bet with it's counterparty in St Kitts?

    By Blogger nigeleccles, at 5:28 PM  

  • UIGEA exempts certain transactions, among them, "any over-the-counter derivative instrument" and "any contract of indemnity or guarantee". I'm guessing that the contract between Centrist and Event Futures LLC is a guarantee for Centrist business losses.

    By Blogger Jason Ruspini, at 6:08 PM  

  • I'm guessing that the contract between Centrist and Event Futures LLC is a guarantee for Centrist business losses.

    By Anonymous Anonymous, at 5:07 AM  

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