May 24, 2024

Economix: Bin Laden and Inefficient Markets

Someone else could have made a killing yesterday. Here’s a look at the odds on Intrade, the prediction markets site, on whether Osama bin Laden would be “captured/neutralised before midnight ET on 30 Sep 2011″:


If you were among the tiny minority of Intrade bettors who believed Bin Laden would be caught by or around the 10-year anniversary of 9/11 (or perhaps by this June or this December), you did very well.

An Intrade market is a place where you can buy a contract — a sort of bet — on the probability of an event happening. Contracts trade between prices of 0 points and 100 points, and the point value at any time is what the market considers the percentage probability of that event occurring to be.  Each “point” of an Intrade point price goes for 10 cents in real money.

If the market “thinks” the probability of an event happening is low, and you disagree, you would buy a contract and then wait for the event to happen. If you’re right, you cash in.

Let’s say you saw Bin Laden/September 2011 contracts trading on April 22 at 3.8 points, which means the markets thought that there was about a 3.8 percent chance that he’d be caught by this coming September. You might have bought the contract because you thought the market was underestimating this chance. By late last night you would have found out you were right, and the contract would have closed, or settled, at 100 points.

The settlement point price minus your purchase point prices, then multiplied 10 cents, equals your profit. So when the contract traded from 3.8 to 100, you gained 100-3.9 = 96.2 points. Multiply that by 10 cents, and you get a $9.62 profit for each contract you’d purchased.

If you’d been wise enough to buy these contracts in bulk, as you might for a stock — and alas, the volume traded on this particular Intrade market was quite low, so few were thinking along these lines — you could have made a pretty penny.

Just goes to show that with imperfect information it’s hard for markets to be terribly efficient.

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