Go Ahead and Short Your 'InTrade Will Come Back' Contract

from the betting-the-house dept

While most of you are busily reading about the latest effort from U.S. News to calculate with the incalculable, applying its formula to tease out razor-thin distinctions between law schools, you’re missing the demise of the once lauded Internet prediction site, InTrade. What were the odds?

Over the weekend, the Irish-based website shuttered itself completely, noting in a statement to customers that there may be “financial irregularities.” Uh-oh.

All this comes at the worst possible time for InTrade customers, who were looking to cash in on that sweet, sweet Conclave action…

Customers in the U.S. already lost access to InTrade back in November, when the CFTC waved around a 2005 cease and desist. The CFTC’s beef with InTrade revolved around the website selling contracts that looked an awful lot like commodity futures. The CFTC does not like commodity futures traded from outside their regulatory framework. And even though InTrade specifically asked the CFTC to step in and regulate their trading, the CFTC opted to functionally shut them down (once the Presidential election contracts were all paid out, of course). The CFTC didn’t give a very clear explanation for this decision, but the CFTC apparently felt that allowing micro-level trading on commodity futures constituted a societal ill they could not accept — while institutional investors tossing around trillions seems perfectly harmless. Or the CFTC was just lazy. Never underestimate “just lazy.”

InTrade’s closure over the weekend was not related to trading commodity futures, but some vague suggestion of “financial irregularities.” Details remain sketchy, but the best guess out there alleges that InTrade failed to maintain duly segregated accounts.

What on earth is going on? My best guess is that the margin posted by traders was not held, as it should be, in segregated accounts separate from company funds. When bets are made on this market, both parties must post margin equal to their worst-case loss, so that neither is subject to counterparty risk. In effect, each party is taking a position against the exchange, but these positions are exactly offsetting so the exchange bears no risk. To ensure that all promised payments can be made, these funds must be held in the form of cash, insured deposits, or safe dollar-denominated securities such as Treasury bills. They cannot be invested in risky assets, and cannot be used for the payment of salaries or expenses.

The latter point about the “payment of salaries or expenses” is in line with the recent announcement that auditors had flagged payments to InTrade’s former CEO, the late John Delaney.

The loss of InTrade will spark glowing eulogies from multiple sectors, but losing the political prediction market will be the toughest loss. The political reporting class openly crowed about InTrade’s predictive power for years. The Washington Post already published its lament over the passing of InTrade as the loss of the last, best hope for pundit accountability:

It’s a shame, and this is why. We live in a world of punditry in which there are large amounts of, to put it nicely, horse manure. Those of us who write and talk about what will happen inevitably rely on vague predictions, full of qualifications. I’m guilty of it myself, and often find myself writing things like “this ought to be an OK year for the economy, if fiscal austerity isn’t too severe and there isn’t a return of the European crisis.”

On Intrade, by contrast, the traders who participate and collectively set market prices, are forced to choose—and put money where their mouths are. Will the United States enter a recession in 2013? Before it shut down, the prices for that contract on Intrade implied a 16.9 percent chance that the answer was “yes.” In a world in which people hold their pundits to a higher standard, people spouting off on the economy (or politics, or foreign affairs, or the selection of the pope) would be forced to make specific, testable predictions, and attach probabilities to those guesses.

I actually thought the best hope for pundit accountability would be a media willing to confront their own pundits with past flawed predictions, rather than sweeping the past under the rug every day, but what do I know?

But the legal fallout from the end of InTrade, for the U.S., will be the inevitable rise of the next online predictive market. With InTrade out of the way, some other online gambling site — anyone from PaddyPower to Betfair — will grow into the hole created by InTrade, subtly open itself to U.S. customers, and likely reignite the legal battles with the CFTC all over again. Hopefully, next time around, cooler heads will prevail at the CFTC and welcome these predictive markets to the regulatory regime.

But I’m not buying that contract.

To Our Customers [InTrade]
A Prediction Market Mystery [Rajiv Sethi]
RIP Intrade: The Last, Best Hope for Pundit Accountability [Washington Post]
Now You Can’t Buy Your Crude Oil Futures In $10 Increments On Intrade [DealBreaker]

Filed Under: failures, prediction markets
Companies: intrade

Making Sure Bets On Online Prediction Markets

from the psst-i-have-a-tip dept

Online prediction markets like Intrade have started to make a name for themselves in this year's exciting political arena. By trading futures on political outcomes like the Democratic and Republican presidential nominations, the idea is that the efficiency of the market will ultimately serve as a better predictor of outcome than traditional methods like exit polls. However, as some traders are starting to find, prediction markets still have many inefficiencies in their current state, allowing shrewed traders to make tidy profits as a result. In the Intrade market, a political future is worth $10 if the political outcome occurs, and $0 if it does not occur. Therefore, a $5 market price on a particular future is supposed to correlate with a 50% prediction of that future to occur. However, in practice, certain factors push these prices out of the range of their realistic probability. For example, contracts for Ron Paul's predicted as high as a 9% chance of him being selected as the Republican nominee, when in reality, his chances were probably closer to nil. Perhaps driven by a small cadre of Paul supporters, the Intrade market was able to be swayed by a small number of trades. Even today, Intrade shows Paul at a 1.2% -- which is a great opportunity for someone to make money on taking the short side of that contract. On the Democratic side, Al Gore supporters have put a 1% chance on his head, who never even appeared on the ballot -- wishful thinking indeed. That said, the limited amount of volume on these contracts precludes anyone from actually making a crazy amount of money on them, but it does remind us of an important fact about markets -- while they do tend to come up with the right answer in the long term, in the short term, they are incredibly susceptible to very human factors like optimism and group think.

Filed Under: accuracy, politics, prediction markets