Intrade Flaw – The Time Value Of Money

Intrade is a widely-cited prediction market.  Intrade has a serious structural flaw.  Intrade does not include the “time value of money’, making long term predictions less accurate.

Consider the 2012 US Presidential election.  As of right now, the odds are (using the midpoint of bid and ask):

Obama wins – 54.6%

Romney wins – 39.3%

Gingrich wins – 2.5%

Paul wins wins – 1.9%

Others – negligible

Do you see the problem?  The odds only sum to 98.3, rather than 100.

There’s a flaw with InTrade’s margin rules.  If I wanted to place a bet, I have to place a margin deposit equal to THE WORSE CASE LOSS.  I don’t get that money back until November.  I don’t get credited with interest.

Consider Ron Paul.  Realistically, his odds are zero.  However, if I wanted to sell Ron Paul, I’d have to put up $9.81 to gain $0.19, and I won’t be paid until November.  That would be an idiot bet.  My effective interest rate would be around 2%.  I’d be better off investing in the stock market or gold.

Also, I have counterparty risk.  If Intrade declares bankruptcy between now and November, I lose my investment.

Intrade has a serious defect in its margin rules.  You are required to deposit collateral equal to the worst case loss, and you aren’t credited with interest.  That skews the odds for long-term predictions, like the November election.  Longshots may be overpriced, because it isn’t profitable to sell them.  The overall odds are skewed, because you don’t get credited with interest.  Even if interest were credited at a rate of 1%-2%, that’s still lousy compared to other investments.

8 Responses to Intrade Flaw – The Time Value Of Money

  1. > Consider Ron Paul. Realistically, his odds are zero.

    Who says? What is the arithmetically basis for your decision?

    The mainstream media always dismisses him as having no chance and so suggest it is a wasted vote.

    You are doing the same thing.

    Maybe tomorrow people will wake up a get a clue.

    It would certainly be worth it just to get an honest President.

    • Ron Paul is my favorite candidate, but realistically he has no chance of winning.

      If it were possible for Ron Paul to get elected, he wouldn’t need to run.

  2. Yes, but you are essentially telling people not to vote for him because he has no chance.

    It is a self-fulfilling prophecy.

    Don’t you just hate it that every time the mainstream media mention him, they say he has no chance of winning!!!!

    • I’ve mostly given up on the idea of reform via voting. I’m looking towards other things.

      For example, I decided that it wasn’t worth the effort to change my registration to Republican, so I could vote for him in the NY primary.

      “Vote for Ron Paul!” is itself a form of pro-State trolling. Freedom is a lot more work than voting for the right person.

      However it is encouraging that Ron Paul is getting around 10% of the vote. That’s a lot of anti-State sentiment. However, most of those people are still thinking “If only we could keep government small!” instead of market anarchism.

  3. Although off-topic, the main problem in the United Kingdom is that rents, property prices, taxes on selling homes, estate agents fees and taxes in general are too high.

    This means people cannot move home to get new jobs.

    This means people can’t start their own businesses as too much income has to be diverted into paying taxes and paying rent.

    This means people cannot move off of welfare to do low-paying jobs.

    • You’re blaming the symptom and not the cause.

      Rising rents and home prices are a symptom of inflation.

      As another example, I’m trying to save up my salary to someday start my own business. Inflation makes this much harder. My investment returns don’t keep pace with true inflation. That makes it harder for me to accumulate savings and bootstrap a business.

      Salaries don’t keep pace with inflation, because State insiders are grabbing a larger and larger chunk of the economic pie.

  4. I like this article, but it makes the flaw of treating a near-risk-free return of 2% as unacceptable. Stocks and gold have a different risk profile and time horizon. Also, if odds collapse to 0.01, you get paid early, which is a possibility.

    The intrade counterparty risk is something I am intrigued by. Theoretically, there should be no counterparty risk from bankruptcy, assuming they are ethical and simply acting as a clearing house. Then again, look at MF Global to test that theory.

    • If you’re willing to buy a bond that pays 2% interest, you’re an idiot. You’ll get ripped off by inflation.

      Some Treasury bonds yield 2%. The Federal Reserve manipulates interest rates, keeping them much less than true inflation. Treasury yields are not the result of a free market.

      Whenever you use Intrade, you are lending Intrade money at 0% interest. You are an unsecured Intrade creditor, if Intrade declares bankruptcy, or if Intrade pulls a Corzine. Intrade gets to use your money interest-free from now until the contract expires.

      Does Intrade have the same capital requirements as other businesses? Is customer money segregated? Even if it’s supposed to be segregated, Intrade’s executives can always lie!

      Even if Intrade did credit a couple percent interest, that still is much less than true inflation.

      Would you buy an unsecured Intrade bond that paid 0% interest? Would you buy an unsecured Intrade bond that paid 4% interest? If you answered “yes” to either of those questions, you are an idiot.

      Intrade does not credit people with interest. If you’re making a prediction for a 1-2 week time period, lost interest doesn’t matter much.

      For 1-2 year predictions, like the Presidential election, the loss of credited interest is significant.

      That also causes longshots to be overpriced, if they have a dedicated fanbase. Ron Paul’s Intrade odds were decent, but he had no realistic chance of winning. Intrade’s capital requirement rules meant that it wasn’t profitable to sell Ron Paul on Intrade, even though it was overpriced.

      Even if I had advance knowledge 2 years ahead of time, regarding who will be the next President, a physical gold investment would probably be superior to an Intrade bet. When performing the comparison, remember to include the Intrade default risk, the odds that Intrade will steal your money and declare bankruptcy. If you were a futures market customer, your default risk was 16% in 2011! (MF Global was 40% of the futures market, and MF Global customers lost approximately 40% of their equity.)

      If you look at recent price history, gold has been giving great returns, with practically no risk. When was the last time the FRN-denominated price of gold decreased over a 3 year holding period?

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