Friday, August 06, 2004

IEM good, PAM bad? 

An excellent article at the Mises Institute is asking this question and points out an excellent arbitrage opportunity:
The first time I looked at -- an Irish sports gambling site that operates through an international exchange of contingent contracts -- they were putting the chances of President Bush's re-election at 60% (i.e., a $100 BUSH WINS contract was priced at $60). The clients of spend real money on real contracts, taking real risks in pursuit of real reward. The virtual prediction market site, also offers contingent contracts on President Bush's re-election chances, but both purchases and pay-offs are done with play money. Their "market" gave Bush only a 49% chance of re-election. This was in the spring of 2004. One obvious empirical test would be to compare how close the different sites come to predicting the actual election results -- will the local knowledge of the local American website outperform the profit-driven predictions of the international gamblers?

As I write this, in the summer of 2004, I can't yet know. What I do know is that an 11-point discrepancy in contract prices couldn't last if both markets were based on the risk of real money. If both markets really paid a hundred dollars for their $100 contracts -- and if they were both active enough to allow a large number of such contracts to be traded -- then arbitrageurs could guarantee a certain return in November. By buying the cheaper contract in each market -- the $40 BUSH LOSES in one market and the $49 BUSH WINS contract in the other -- they could guarantee a $100 pay-off for an $89 expenditure (ignoring transaction costs). Note that the arbitrageur doesn't need to have any opinion of Bush's re-election chances: he is, after all, betting both ways. All that is necessary for the arbitrage profit opportunity is a disagreement between the two markets: a discrepancy in their prices.
Anyone going to trade this?

And what is the implication of this for the
Policy Analysis Market?