A bad bet

I do some small-time betting on Intrade, an on-line market where people bet real money on everything from box office openings to US legislation, and from the performance of the Dow to global temperatures. It’s pretty simple to do: every contract is ‘worth’ $10 (100 points) to the person who wins, but can be bought or sold at any time before vesting for a price between $0 and $10. Thus, the market price should reflect the approximate percentage chance of the event occurring according to the collective wisdom or idiocy of the market. For example, today the contract on whether or not the US will enact a ‘public option’ before December 31, 2009 last traded at 21.5 points, or $2.15. In other words, the market seems to think that there is a 21.5% chance of this happening, and a bettor has to risk only $2.15 on the chance to net $7.85. Those are some long odds.

And it’s also an illustration of how much work Intrade has to do if it wants to make itself relevant to more than a few thousand hard core bettors around the world.

For those of you who read the news, it might surprise you to learn that the market gives the public option (PO) such a low probability of being enacted. After all, it’s guaranteed to be a part of the House bill that Pelosi cobles together (whether in the robust Medicare+5 form, or in the weaker market negotiated form), and it is looking more likely that Reid will include the PO in the senate floor bill as a nation-wide plan that allows individual states to opt out. The president finds a way to leak to the press every couple of days his continued support for the PO, and public opinion polling indicates that a clear majority of America supports the PO. And yet it’s only trading at 21.5? In an efficient market, wouldn’t a savvy better who follows the story more closely than your average schmo bid up that price by snapping up such a deal?

The devil is in the details. The contract details, that is. Every contract on Intrade has a description laying out what specifically will make the contract vest at 100 an what will make it vest at 0. Obviously it’s important to make the fine print as detailed and clear as possible, so that people can properly assess the probability of winning and losing before they trade.

And when Intrade first opened up trading on the PO contract back in June, the fine print seemed clear enough:

“This contract will settle (expire) at 100 ($10.00) if a US federal government run health plan (a public option) is approved in the United States before midnight ET on the date specified in the contract. The contract will settle (expire) at 0 ($0.00) if a US federal government run health plan (a public option) is not approved in the United States before midnight ET on the date specified in the contract. A federal government run health plan will be considered approved once legislation establishing the plan has been passed into law. Expiry will be based on the passage of the required legislation into law, as reported by three independent and reliable media sources. This contract covers only the creation of a government run health insurance plan that is an alternative to private health insurance. It does not cover existing health insurance programs such as Medicare or Medicaid, or any changes made to these programs or the cover they provide.”

Clear enough. I’d need a “federal government run health plan” before the end of the year to win this contract.

Let’s say that a bettor comes along and sees the contract trading  in the 20’s a couple months ago. (Full disclosure: I’m long in the PO market by 6 contracts). It’s early in the legislative process yet, but things look more promising than the prevailing price indicates. And as the legislative process moves on, we learn more about the specific compromises under consideration and Intrade makes some clarifications to the original contract rules. First, “co-ops” won’t vest at 100 because they aren’t run by the federal government. OK, seems reasonable. Then Snowe’s “trigger” won’t vest at 100 because it wouldn’t actually establish a PO and instead leaves that to some indefinite future. OK, seems reasonable.

But then comes another ‘clarification’ to the original contract rules from Intrade:

For the purposes of this market any public option must be national for the contract to expire at 100. If it was offered in certain states then not others then the contract would not be expired at 100 (added 08/09/09).

Where does it say anywhere in the original contract text that the PO would have to be national in scope? A reasonable person could read the original contract text, consider the likelihood of a state opt-out or opt-in compromise, and still be under the impression that the contract would vest at 100. That is, until Intrade decided to change the contract rather than clarify it.

And that’s why the “PO” today is given only a 21.5% chance of being enacted by the market. Sure, I stand to loose the value of a lunch for 1 at Applebees because of these contract revisions. But I don’t even really like Applebees that much. More importantly, this process shows how Intrade needs to revise its practices before it and other online prediction markets can go truly mainstream.

Intrade was founded in 2001, and economists and wonks immediately gave it and other predictions markets glowing reviews.  The time was ripe for enthusiasts to adopt prediction markets. Economics had muscled its way into poly-sci departments, and the New Yorker’s James Surowiecki had coined the term “The Wisdom of the Crowds” to describe the benefits of aggregating private knowledge and opinion in the service of decision-making. The Pentagon tried to set up a mechanism to harness the “wisdom of crowds” to predict future terrorism events. John Tierney at the New York Times breathlessly called Intrade “the greatest time-saving invention of this century.” ABC’s John Stossel and David Leonhardt in the NYT both said that instead of wasting time listening to pundits, people could soon turn to prediction markets to figure out what is likely to happen in the future.

But widespread participation in prediction markets has yet to materialize. And this is likely to remain the case so long as prices  are pushed out of sync with common sense odds by the arbitrary revision of contract details. It is discouraging for a bystander considering joining Intrade to see that odds for the public option as defined in the contract remain so far out of sync with the odds of the public option as commonly understood by the rest of the world. Your marginal market participant will look at that disparity and grow worried that market insiders will take him for a ride in a system that is opaque.

As a result of the problems with the PO contract revisions, as well as some other recent debacles on Intrade, the sheen has come off of prediction markets. Pundits are not so breathless anymore when talking about Intrade. As with most new ideas, what once was seen as a panacea is now merely one amongst many flawed but promising ideas.


2 Responses to “A bad bet”

  1. 1 JSC5 October 27, 2009 at 5:07 pm

    A quick update to reinforce my point:

    Yesterday, Senate Majority Leader Harry Reid announced that he has submitted a merged version of the health care reform bill to the CBO for scoring … and it includes a public option with an opt-out clause for states.

    Sounds like great news for the public option, which seemed dead just a few weeks ago.

    And yet right after Reid’s press conference was over, the “Public Option” contract on Intrade.com plummeted from over 20% to under 10% odds for winning.

    And Intrade is supposed to be a useful shortcut for traditional political analysis?

  1. 1 A bad bet Trackback on October 24, 2009 at 8:45 pm

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This is a group blog. JSC5 currently writes from the US. JSC7 writes from behind the Great Firewall of China.

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