Thursday, May 24, 2007

Greg Mankiw ponders Intrade arb on Dem POTUS candidates

Alerted by one of his readers, Mankiw asks:
Here is an apparent arbitrage:

Sell Clinton (bid is now 38.3), Obama (16.5), Gore (7.3), and Edwards (3.6) for a total of 65.7. Buy a contract for a generic Democratic win (ask is now 56.8). You pocket the difference (65.7-56.8=8.9). You have to pay out on the first contract if one of these four candidates wins, but in that case you are covered by the second contract. The only contingency in which you lose is if Clinton, Obama, Gore, or Edwards end up president as an independent or Republican candidate, which seems completely unlikely.

So why am I giving away this arbitrage opportunity for free? I must be either unsure of my analysis, or motivated by the search for truth rather than money. Your call.

At the time of my post, the commenter jck says:
"If a named individual from this group, 2008 US Presidential Election Winning Individual, receives his/her political party nomination, the named individual contract listed in this group will be merged into the relevant political party contract in the contract group named 2008 US Presidential Election Winner (Political Party).
E.g. if the Democratic Party nominates Hillary Clinton as their candidate for the 2008 presidential election, all Open Interest (member open positions, not open orders) in the contract 2008.PRESIDENT.CLINTON(H) will be merged into the Democrats to Win contract in the contract group titled 2008 US Presidential Election Winner (Political Party)."
Therefore if you are short H.CLINTON and long "Dem to Win" your positions self-cancel.
For the nominee issue,I mean that it is possible for the initial nominee to be different than the final one,without being morbid for exemple:accidents happen,scandals happen that case the merging will not be reversed according to the rules and another candidate would be nominated who will also be subject to the merging rule except this time you do not have a long position in "Dems to Win",so you are no longer in an arb situation but a speculative short.
Another rule than can create havoc with this arb is in the notes:"In the unlikely event of the untimely death of one of the named individuals, all trades will be unwound and fees reimbursed to members accounts. (This only applies to contracts that have not been merged with a Political Party contract)."
This means that you won't get the proceeds of a short position on a non-nominated individual if he doesn't survive past the election results.To be sure we are talking long shots but in risk arbitrage one should try to anticipate most possibilities and read the rules carefully to see how they will be handled...This arb is fairly priced given transaction costs and cost of money,and i wouldn't do it for that reason.
jck sounds like someone who makes money at Intrade/TS. Not a rare breed, but not common, either.

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