# Enthusiasm and Arbitrage Opportunities at Media Predict

Another play money arbitrage explanation, much easier than the last one.

I sat down to the computer this morning at exactly the time emails were arriving from Media Predict announcing the opening of five new markets for the &#8220-Project Publish&#8221- finalists. One of the five finalists will receive a book deal.

In the prediction markets, five new shares were launched at \$50 (\$ = Media Predict play money). Shares held in the winning book will be paid \$100, the others will expire at \$0. So, at market launch, selling one each of the five shares would gain \$250, and guarantee a payoff of \$-100. Result: riskless profit of \$150. The market should have launched at \$20 each (or, at least, that is one set of prices that would have eliminated the riskless arbitrage opportunity).

First to the new markets, I sold short what I could afford across the board, bringing all the prices down to \$35. An hour or two later prices had drifted up on several shares, no doubt due to the enthusiasm some trader had developed for the books, but in their enthusiasm they didn’t realize that they should complement a purchase of one share with sales of other shares – otherwise they leave free arbitrage opportunities in the market. A bit later someone came along and sold all of the share prices down to \$20 each.

Now, several hours later, prices have moved much higher on three of the books, while two seem to be drifting lower. I’ve sold some other Media Predict holdings so I could arbitrage some more, but I’m credit constrained in the Media Predict economy so I can’t grab all of the riskless profit. As I write, the current gain from selling a one-of-each suite of shares is \$156, so the present riskless profit available is \$56.

While the book shares are presented as five parallel markets, actually we have a single multi-outcome market. There are five books, and only one of the five will be selected. Since the sum of the probabilities across the five books is constant, if you think option A is more likely to win then it must be the case that the joint probability of B, C, D, and E is less likely. The market can take advantage of that relationship to improve market performance, for reasons that Chris Hibbert explains in “Increasing Liquidity in Multi-Outcome Claims.” If the market won’t do it, arbitrageurs can.

Note: Chris Masse was puzzled about bigger picture issues in his earlier post on Media Predict, and I comment on some of those issues in response. For the purposes of the post above I’m ignoring the big picture and just wondering about the market mechanism and implementation.

## 4 thoughts on “Enthusiasm and Arbitrage Opportunities at Media Predict”

1. Chris. F. Masse said:

Fascinating blog post. I read it from a to Z, sipping every word.

Should we understand that the Media Predict should have presented things differently or not?

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2. Michael Giberson said:

The problem with the implementation of the Project Publish finalists is that it complicates the interpretation of the market “prediction.”

When I look at the current prices (\$52.10; \$21.76; \$41.00; \$24.90; \$71.18), the natural reading of the market would be that the first contract has a 52.1 percent chance of being the selected book, the second contract has a 21.76 percent chance, and so on. If you add them all up, you see that jointly, there is a 210.94 percent probability that one of the books will be selected. But that is nonsensical, since the rules state there is exactly a 100 percent chance that one of the books will be selected.

In my view, they should have joined the five contracts into a single market using Inkling’s multi-outcome market engine. With such an implementation, the market enforces a joint implied probability limit of 100 percent, so a purchase of one contract diminishes the prices of the other contracts in offsetting amounts.

It should be a simple matter to use the multi-outcome market engine “underneath the hood” while still presenting the five books on separate pages, as Media Predict seems to prefer.

3. Jason Ruspini said:

I think they are aware of this and the idea is that launching markets away from fair value and maintaining arbitrage opportunities encourages user participation, especially on the shorter term contracts. “There are more things in heaven and earth, Horatio…”

4. Michael Giberson said:

Jason, you may be right. And, after all, since it is a play money exchange, it doesn’t really cost them anything to launch markets away from fair value to subsidize the early traders.

I think it is an open question as to whether maintaining arbitrage opportunities in this way — using five separate single-outcome markets — does a better job of encouraging user participation than the alternative — using a single multi-outcome market. I haven’t seen any data on this point.

If it is strategy rather than desire-for-simplicity that lead Media Predict to this implementation, then the question is whether the subsidy is going to the right places. As I mentioned, mispricing the launch subsidizes the early traders at the expense of the sponsor. Maybe appropriate if you want to encourage quick market take-off.

If your design tends to throw off arbitrage opportunities because it lacks the coordination provided by a single multi-outcome market engine, the it tends to subsidize informationless-trading by arbitrageurs at the expense of less sophisticated traders (who don’t realize that their enthusiastic purchases of contract A should be offset by sales of B, C, D, and E).

I don’t see the value to the market in encouraging informationless trading. Wouldn’t it be better to have less informed traders subsidize more informed traders? That’s the kind of subsidy that motivates information gathering, which is, after all, usually what the market operator wants.