September 29, 2004

silhouette3.JPG From the desk of Jane Galt:

Buy Kerry, sell Bush?

Farhad Manjoo is arguing that Bush is overvalued on the Iowa Electronic Markets. Someone sure is; the prices of the four contracts available (Bush wins more than 52% of the vote, Bush wins with less than 52% of the vote, Kerry wins with less than 52% of the vote, and Kerry wins with more than 52% of the vote) -- sum to more than $1. Since the potential payoff of each contract is a dollar, and those four possibilities are the complete universe of possible outcomes, their prices should total to $1, in an efficient market. I presume the problem is that you can't sell short on Iowa, which makes it harder for information to travel between the Bush market and the Kerry market.

Posted by Jane Galt at September 29, 2004 11:56 AM | TrackBack | Technorati inbound links
Comments

FWIW, on TradeSports, Bush was around 68 a week or two ago when he was around 60 at Iowa. Now, Bush is around 67 at TradeSports (down from 70 earlier this week) while Bush is up to 70 at Iowa.

And your point that we cannot short Iowa is quite interesting. To coin a Yogi-ism, since I can't sell Bush at Iowa, I would.

Posted by: Tom Maguire on September 29, 2004 01:21 PM

Could it be that the reason the total of the 4 options does not equal $1 has something to do with transaction costs? I'm asking. I don't know how the market is structured.

Posted by: David Walser on September 29, 2004 01:57 PM

The total value of the four contracts does indeed equal a dollar. In fact, you can buy a bundle of one of each contract from the exchange for the fixed price of a dollar. So if the some of bids is greater than a dollar, you can buy a bundle for a dollar, and immediately sell it for a profit. I think the reason the sum-of-bid-prices might be greater than a dollar at some instant (the current quote adds up to exactly a dollar) is simply because there is not enough volume to make that correction instantaneous.

Posted by: Will Headden on September 29, 2004 02:37 PM

Clearly I should proofread: "the some of bids" should be "the sum of bids".

Posted by: Will Headden on September 29, 2004 02:41 PM

'Shorting' in a sense is certainly possible, by buying the three non-shorted contracts -- IEM permits market participants to buy 'the package' at a dollar. so with as little as $1 on account, any contract can be effectively shorted. The IEM could link all four contracts (automatically implying no-arb bids and offers) but for no good reason doesn't; it would certainly help liquidity.

The reason contracts on IEM seem routinely inflated has more to do with laziness of buyers who woud rather abandon a penny or two than do the math.

Tom, the Tradesports contract to compare with IEM would seem to be KERRY.POPULARVOTE; it has traded on average 3 or 4 points richer than the more liquid electoral victor contract (suggesting another arb.) With Kerry at .30 on the IEM, a nickel spread could yield an accountholder around 80 bucks for every $500 (the IEM max deposit). Not bad, but I'd rather spend the cash buying (kerr >52%) in size on the IEM for 8.5 cents.

Posted by: Alex on September 29, 2004 10:20 PM

Holy Cow! I had no idea that TradeSports was bothering with the phony, "Florida Rules" Iowa style popular vote winner.

And I see today's volume for "Bush wins popular vote" is 73 contracts, vs. 2300 for the straight "Bush Wins".

That said, the "Bush Wins Pop Vote" is about 63 at TradeSports, which, if I am following, is the contract to which Iowa should be compared.

That further suggests that Iowa and TradeSports are out of line.

As to Kerry >52? Gore couldn't get to 52 as an incumbent; Clinton never broke 50 (with Ross Perot around).

Is there some weird quirk to Iowa, where they recalculate vote share after dropping Nader? Hmm, I see from the prospectus that there probably is:

For instance, the contract DEM04 could be split into two contracts, DEM04_G55 and DEM04_L55, where DEM04_G55 denotes the case in which the Democratic nominee receives the most popular votes AND that the Democratic voteshare is 55% or more of the total two-party vote...

Alright, there is the obvious way, and the Iowa way. Still a bad bet, IMHO.

Posted by: Tom Maguire on September 29, 2004 11:36 PM

Gore won the pop vote, but the pres was elected by the Supreme Court 5-4. I still remember in 2000 how the voting places in the black area of town closed early. Hmmm? Also many blacks were unfairly accused of being felons in Florida and not allowed to vote.

While walking through his whitehouse lair.
I met a president who wasn't there.
He wasn't there again today.
I guess his brain walked away.

Posted by: CarlosX on October 3, 2004 08:48 PM

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