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Wednesday, October 24, 2012

Attempted Price Manipulation at Intrade? Probably Not.

Rajiv Sethi argues that the abrupt change in the price of presidential contracts on Intrade was probably due to something other than attempted manipulation of the market to make Romney look better:

Algorithms, Arbitrage, and Overreaction on Intrade, by Rajiv Sethi: There were some startling price movements in the presidential contracts on Intrade yesterday. ...
What caused this unusual price behavior? There's been some talk of attempted price manipulation, but I have my doubts because the trader who was buying aggressively over this period was extremely naive. ... Throughout the buying frenzy, the Obama contract never fell below 57 and there was a substantial block of bids at or above this price. The trader who was buying Romney at 48 could have made the same bet for 43 by simply selling the Obama contract at 57. In fact, he would have obtained a slightly superior contract, which would pay off if any person other than Obama were to win, including but not limited to Romney.
This fact also explains the oscillations in the Romney price, and the decline to 57 under selling pressure of the Obama price. Any individual who had posted ask prices in the 43-48 range in the Romney market had these orders met by the crazed buyer, and could then sell Obama above 57 for an immediate arbitrage profit. As it happens, there are algorithms active on Intrade that do precisely this. ...
If this was not an instance of attempted manipulation, then what was it? I suspect that it was an overzealous response to reports of a major announcement concerning the presidential race, promised by Donald Trump. Further frenzied activity in the presidential and state level markets took place in the evening, as speculation about the nature of the announcement started to spread.
This whole bizarre episode tells us very little about the presidential race, but does shed some light on how these markets work. Changes in one market spill over instantaneously to changes in linked markets via arbitrage, some of it executed algorithmically. And algorithms that work very effectively when rare can end up with disastrous results if copied. For instance, if two algorithms were to follow the strategy outlined above, it is possible that only one of them may be able to complete the second sale since the first mover would have snapped up the existing bids. This kind of game is currently being played in the world of high frequency trading, but with much higher stakes and considerably more serious economic consequences.
Whoever it was lost money, which seems an appropriate outcome for putting one's faith in Donald Trump's crazy ramblings.

    Posted by on Wednesday, October 24, 2012 at 09:18 AM in Economics, Politics | Permalink  Comments (20)


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