Lease a car before August 26, and if it’s above 96 degrees at Boston Logan Airport on Labor Day, they will make your first 12 lease payments for you (minimum 36 month lease term).

This reminds me a lot of Jordan Furniture’s “free furniture if the Red Sox win the series” promotion, which prompted me to ask if sports betting was now legal if you bundle it with furniture?

A difference with the Jordan’s promotion is that the implied amount of betting here is actually pretty trivial.  First, note that a year’s lease payments are only about 15 percent of the value of the car.  Second, the odds of temperatures that high at Logan are tiny (Logan is surrounded by Boston Harbor, which may help moderate the temperatures).

Weatherbill.com is willing to sell me for $69,000 a contract that pays $1,000,000 per day with a high above 96 at Logan in the 15-day window surrounding Labor Day.  Divide by 15 and you have a market-implied probability of 0.46%.  Weatherbill also tells me that in the last 30 years this contract would’ve paid $33,333 on average, for a historical probability of around 0.22%.  So the actual expected discount implied by this promotion is around 0.033% to 0.069%, compared with 10% for Jordan’s.

One interesting thing about this promotion is how the commercial starts (I’m paraphrasing):  “92 degrees, 90 degrees … it’s been cool lately, but remember those scortching Labor Days …”  They are clearly playing on both the Gambler’s fallacy and its reverse, just at different frequencies.

But my main takeaway is:  could gambling policy in the country be any more screwed up?

P.S.  Some interesting follow up on Jordan’s:  they were sued over the promotion by a man previously convicted of running an illegal lottery, who bought furniture during their 2008 promotion and then sued after the Red Sox did not win that year.  The letter from the Mass AG posted in comment #2 indicated that the AG reviewed the promotion and decided not to take action.  So I guess the answer to my question is that betting is legal if bundled with a product, at least in Massachusettes.

The suits against Jordan’s have (predictably) been struggling.

As we’ve discussed before in other contexts, one can divide two probabilities like these to obtain a conditional probability: e.g., if the Democrats put X on the ticket, they will win the general election Y% of the time (where Y = odds of X becoming VP/odds of X being nominated).

These markets are thin, so the conditional probabilities should be taken with a grain of salt. But they are interesting nonetheless:

The pattern I see here is that conditional probabilities are higher for fresh faces (Webb, Sebelius; and arguably Bayh and Richardson despite their longer tenure) than for the old guard (Clinton, Nunn, Biden).

Of course, these should be viewed as correlations, not necessarily causal effects. For example, two possible explanations are: 1) putting a fresh face on the ticket helps Obama, either because there is less baggage or less of a contrast in national-politics resume length, or 2) Obama will only pick an old guard candidate in the state of the world in which he needs to shore up a weakness (i.e., picking Clinton to end a civil war, or Nunn to add foreign policy experience).
On the GOP side:

Huckabee has the highest conditional probability, and Pawlenty and Jindal are noticeably lower. Interpreting this one is harder: it depends on what aspect of Huckabee one thinks the market is expecting to be appealing (religion, likeability, Southernness, selective economic populism).

Technical note: the bids and asks reported above are actual quotes scrapped this AM; the mids are (bid+ask)/2, rescaled to add to 100 across all candidates.

But would Musharraf’s fall be good news? It’s not obvious, since we don’t know who will replace him (i.e., Bhutto or someone more anti-Western). And even if it’s Bhutto, we don’t know how much help she’ll be once in office.

Intrade has just listed a contract that may help provide an answer. In addition to adding Musharraf to their foreign leader departure series (as Chris noted yesterday), they also added a parlay for Musharraf leaving and Osama being captured (at my suggestion). So if these contracts turn out to be liquid, we’ll be able to get a market-based estimate of the correlation between Musharraf and a reasonable summary statistic for whether outcomes in Pakistan are good for the West.

Of course, the usual caution about correlation and causality applies here. If Osama is caught tomorrow, it probably helps Musharraf keep his job. The longer term conditional probabilities should be less contaminated by this problem and the difference betweens between the prices of the long and short dated contracts might be used to contract a clean(er) estimate of a causal effect.

This seems like the most interesting geopolitical decision market to come along in a little while. But it’ll only work if it’s liquid. So those of you with Intrade accounts, put up an order or two. Your country needs you.

Jordan’s shoppers sitting pretty if Sox win

Thousands of Red Sox fans could be sitting in free seats soon – if their team wins the World Series.

Jordan’s Furniture, the Warren Buffett-owned local chain famous for commercials featuring brothers Barry and Eliot Tatelman, earlier this year promised free furniture – including sofas, dining tables, beds, and mattresses – to customers who bought between March 7 and April 16, so long as the Sox win the fall classic. Now, there’s a real possibility that Jordan’s could be paying back millions to customers.

“Imagine yourself sitting on that sofa, watching that game, and knowing it’s free if they win,” said president and chief executive Eliot Tatelman, who is already appearing in new commercials reminding fans of his commitment to pay them back.

He wouldn’t disclose how much Jordan’s might have to pay out, but the money won’t come out of Jordan’s bank account: Tatelman bought an insurance policy to cover any losses in the event the Sox win the title.

Still, Tatelman said the chain took almost 30,000 orders during the contest. One customer stands to get back $40,000, Tatelman said.

“He did his whole house,” he said.”

Now, I’ve got no desire to get these guys in trouble (even if their commercials were pretty annoying when I lived in Boston), but it’s interesting to note that since the Sox were about a 10 percent shot to win the series at the start of the season, the guy who paid $40,000 was really paying $36,000 for furniture and putting $4,000 on the Sox. If this one gets the nod, expect to see more of these promotions.

• Total volume in 2004 Democratic nomination markets: $5.2 million (data is taken from a talk I gave in San Diego)
• Volume in 2008 Dem and GOP nomination markets (with 7 months to go before the primaries start): $24 million

Update:

• CFM asks below whether the higher cumulative volumes on the 2008 contracts just reflect lots of trading in 2005 and early 2006.  I didn’t have an answer at the time, but if one recalculates the cumulative volume in the nomination markets as of today (10/24/07), it is $30.2 million, up about $6 million from early July.
• So more volume in the last 3.5 months than in the entire history of the 2004 markets.  Of course, there are two nomination fights this time around, but there are also still months to go before the primaries.
• This, together with the fact that there are many more political markets on Intrade competing for liquidity, suggests that InTrade’s politics markets are alive and well.

“I think the potential for manipulation troubles some prediction market folks because it puts an implied asterisk next to any prediction market price that says “caution: the price you currently observe in this market may not truly represent the collective opinion of the population of traders, but instead may reflect an attempt to manipulate the market outcome.” The possibility of manipulation taints the purity of the price as a predictor.”

In other words, even if in a rational expectations equlibrium the anticipated presence of manipulators increases prediction market accuracy, that may not be the same thing as it being good for a prediction market.

As sources of inaccuracy go, people dislike manipulation a whole lot more than (honest) noise. For three (non-behavioral) reasons:

1. People have a taste for institutional integrity itself.

2. The possibility for manipulation creates bad incentive effects. Think of a social planner who has to chose whether to base a policy on a noisy, but manipulation-free, signal or a less noisy but manipulable signal. Putting weight on the latter has incentive effects that can produce behavior that offsets the benefit of a more accurate signal for policy choice.

3. Noise is easier to mentally model. Manipulation, to be successful, relies on surprise. Thus, by definition, if its successful, it’s going to be harder for users of prediction markets to understand. And a hard to understand source of uncertainty is more vexing to users of a prediction market price than just simple noise.

Early auctions have yielded values way below Black-Scholes and other methods. Norris is skeptical that these auctions are just a trick to help companies underexpense their options. He quotes Stephen Ross (whom I took asset pricing from at MIT), who worries that the auction values are essentially bid prices, and if the market is illiquid, bid prices may understate value.

Obviously, what Zions wants to do is not that far from running a prediction market. Frankly, it’s a pretty clever idea.

Two thoughts:

1. If others read the article and have the same reaction I do (i.e., where do I sign up to build a portfolio of these underpriced options?), the underpricing from the early auctions may become less pronounced.

2. Of course, if the underpricing is the main reason companies want to run the auctions in the first place, that could kill the idea. So Zions has a strong incentive to set things up in a way that produces low valuations (e.g., restricting access or bid sizes). For this reason, Norris is probably right to be skeptical, but you might imagine some requirements the SEC could impose that would partially alleviate these concerns.

Addendum: Zion’s site is here.

1. The contract had been trading between 23 and 26 all year. It has consistently been about half the price of the “Hillary to get nominated” contract price. This ratio implies that, conditional on nominating Hillary, the Democrats have a 50 percent chance of winning the Presidency.

2. Comparing this with the unconditional probability of a Democratic victory (about 56 percent throughout 2007) suggests that Hillary is a slightly weaker general election candidate than the alternatives (Obama, mainly). [Note I say "suggests" because the comparison of conditional probabilities implies a correlation, but not necessarily that a Clinton nomination would cause a better outcome for the GOP. For more see the fifth question in this paper].

3. Around May 12, someone started buying “Hillary for President” pretty heavily, driving the price up to 40. This price is clearly ridiculous for two reasons:

3a. You could sell the President contracts of Hillary, Obama, Gore, and Edwards for a combined 69 (40+17+8+4) and buy the “Democrat to win” contract for 56.

3b. Since there was no movement in the nomination contract, the conditional probability of Hillary was now a ridiculous 40/52 = 77%, while the conditional probability of “Not Hillary” was 16/48 = 33%.

4. Unlike past manipulation attempts, this manipulator isn’t just dumping a ton of money in to move the price once. He (or she) is moving the price, and then providing support to keep the price high. Note that the price stayed at 40 for about a week (on higher than normal volume).

5. I mentioned the manipulation at the end of my talk at the Palm Desert prediction markets conference, figuring that there was no surer way to get a $100 bill picked up than to tell that crowd about it. Someone emailed Greg Mankiw and he blogged about it the next day. (Justin and I also just tipped off Tyler Cowen). Since then there has been some downward price pressure, but the manipulator isn’t throwing in the towel. He/she keeps replenishing the bid side of the order book, albeit giving ground in the process.

6. By my calculation, the manipulator has spent about $10k to push the Hillary contract up around 12 pts on average for 2 weeks, buying about 8,500 contracts in the process. [I'm assuming 26 is fair value and just summing up volume*(price - 26)].

7. So what do we learn from this?

7a. Manipulation doesn’t have to be as ham fisted as the 2004 Bush reelection contract manipulation.

7b. The manipulators are getting smarter. This manipulator was smarter in one sense by providing price support after the fact. But of course, he/she shouldn’t have pushed the price up to such an obviously ridiculous level (and should have bought and sold other contracts to keep the pricing relationships consistent). The same mistake probably won’t be made next time.

7c. By prediction markets standards, manipulation is expensive. But by political spending standards, manipulation could be reasonably cheap. That said, I can find only one media mention of the inflated Hillary price. $10k for one blog mention probably isn’t great value for money, but the Intrade prices get cited a lot these days, so the manipulator may just have been unlucky.

7d. None of this disputes Hanson and Oprea’s point that, if anticipated, manipulation could increase average prediction market accuracy. In their model, traders all have rational expectations about how much manipulation to expect. In the real world, they may need some help (hence this post).

7e. Although the Hillary price is down to 34.5 (bid-ask midpoint at time of writing), there are about 500 contracts bid above 33, so there is still plenty of free money there if you want it.

(We’ve been waiting for a nice, juicy, controversial merger like this ever since Hp-Compaq.)

Interestingly, the MM has it at 60 bid/70 ask to close by June 08, but if you look at the stock prices of XMSR and SIRI, they have lost some of their initial announcement effect. There might be some free money on the table for the quick (I am abstaining).

If there is interest in this contract, I might be able to get them to run a contract on future subscription prices and subscribers (either conditional on the merger closing or just straight up). If you think about it, this could be an interesting tool for evaluating mergers in the future.

Like the idea? Spread the word.

A couple thoughts:

1. I really don’t see that many accredited investors having so much exposure to daily weather risk that they’ll feel the need to hedge at prices they’ll assume imply negative expected value (given that both Weather Bill and the hedgies they offload risk on need their pounds of flesh).

• Movie theaters are a nice example of someone who is long rain, but they are mostly owned by large chains. Portfolio theory suggests that public companies have no business paying to hedge risks that are not large enough to threaten bankruptcy.
• The law of large #s helps people out with weather. Yes, rain is bad for a golf course, but really they care about a rainy summer (or decade) more than a rainy day. And memberships provide a means of offloading some of that risk on the golfers.

2. Weather isn’t the kind of thing that a lot of people think they know a lot about (unlike, say, sports and politics). So I’m not sure “betting” is going to save them.

3. Part of why the wholesale weather futures market hasn’t taken off and has devolved into an OTC affair is an absence of liquidity trading. Only a few big utilities have a real need to hedge temperature (many are still hedged by the regulatory environment they operate in), and in an open market, there is the worry that you’ll always be trading against someone with a better model than you.

4. What I think is most innovative is the idea of marketing a prediction market contract as “insurance.” But I’d have started with housing. Sell me “insurance” against a 10% or greater decline in the SF property market, and then dynamically hedge with the new CME futures.