Tuesday, October 7, 2008

Cross-market prices

Arbitrage opportunities continue to exist between iPredict and other US election markets. Current prices at midpoint of bid-ask spread:

Note that Iowa event derivatives pay off based on which party gets the larger proportion of votes cast, not on specific individuals, and takes no account of electoral college machinations.

From prior posts, there's at least some reason to suspect that InTrade prices are on the low side for the Democrats. It's neat to see that iPredict falls roughly at the midpoint of the different exchanges.

So, what's limiting arbitrage? First, it's difficult to open an account on the Iowa market if you're not American. Here's their sign-up form. If you want to pay other than by a paper cheque drawn on a US bank, you need to email them to get details for a wire transfer. Second, Americans can't easily trade on BetFair or InTrade because of one crusading moralist from Arizona who can't stand that anybody else anywhere might ever enjoy himself.

But that doesn't explain why non-Americans aren't arbitraging across BetFair and InTrade.

I can't answer for anybody else, but I can say why I haven't started arbitraging between those two markets. First, BetFair's prices are reported as the amount you would earn for a $1 stake, not the amount you would have to pay for a derivative paying $1 if the event pans out your way. So you have to transform prices by 1/x to make the comparison. That isn't too big a barrier though. 1/x is pretty easy. More importantly, BetFair's commission structure is a bit tougher. They take 5% of your winnings. That starts eating into arbitrage profits pretty quickly. And, it's unclear to me whether you can cancel your positions by buying the opposite. In InTrade and in iPredict, if I think the odds of Obama winning are 74%, I can buy Obama whenever the price is less than that and sell those positions if the price gets higher. On BetFair, it looks like the system would treat those as separate positions. I could easily be wrong about that, and I'd love it if someone with more experience in BetFair could set me straight here. But I'm worried that, in BetFair, my position would be locked in until expiration, at which point I'd be subject to the 5% fee. The help files suggest that, if you have positions that cancel each other out, the system doesn't freeze margin on it. But that doesn't save you from having to pay commission on whichever side of the market pans out.

Any better explanations on why arbitrage isn't happening?

Update 9 October, 2 PM: Egads!!! Obama prices:
InTrade: 0.657
Iowa: 0.824
BetFair: 0.8197
iPredict: 0.765

There is a 17 cent spread between InTrade and Iowa. Spend $0.657 to buy Obama on InTrade, spend $0.176 to short Obama on Iowa, and you're guaranteed a dollar for a $0.833 investment: a guaranteed 20% return. Well, near guaranteed. If Obama wins the popular vote but loses the election, you lose both sides. If you go with BetFair instead of InTrade, you lose 5% as commission, but that still seems worth it at those arbitrage margins.

Update 2:21 PM: Obama's up to 70 cents on InTrade. Still a big gap though!


Russell said...

Intrade charge 5% commission to buy and also to sell.

Crampton said...

Commission is only charged on price takers though; folks who seed the order book aren't charged. Or at least that's how it worked last I checked.