Why Prediction Markets Don’t Quite Work

Here’s a fun Intrade price anomaly that showed up this morning. The markets indicate that there’s more than a 3 percent chance that neither Barack Obama nor Mitt Romney will win the presidential election. That’s clearly way too high. But the Intrade betting market lacks the amount of liquidity and derivatives instruments that would be necessary to make it simple and worthwhile for an arbitrageur to spot this and take advantage of it. Austin Goolsbee saw it, tweeted about it, then I decided to write a blog post about it. If something like that happened on a really deep and liquid market, some trading algorithm would have long since made the moves that eliminate the anomaly but it doesn’t work on Intrade.

And this is for basically the highest-profile political betting market you can imagine. Something like a market on the outcomes of Dutch parliamentary elections or a Florida Secretary of State race are going to have even less money in them and would be plagued by even more anomalies.