# Monthly Archives: November 2007

## InTrade fee structure discourages selling the tails?

The political betting markets seem more efficient this year, so I’m looking at narrower perceived edges and care more about transaction costs.  It looks to me like the InTrade fee structure really discourages selling longshots, if I’m understanding it right.  There are three main costs:

• The trading fee is per-lot, and paid by the price taker.  It is slightly lower for extreme prices (3c vs. 5c).
• The expiry fee is paid by the winner, and is 10c per lot.
• The opportunity cost of having the money at InTrade to cover your margin is the risk-free rate minus InTrade’s interest rate (3% for accounts over \$20K).

Even if we assume always being the price maker, note how the 2nd and 3rd both hurt those who sell longshots much more than those who buy them.  The seller of 1 contract at 5 will (if the price is right) pay the expiry fee 19 times out of 20.  So rather than having a return of \$.50 * (19/20) – \$9.50 * (1/20) = \$0.0, the seller’s return is (\$.50 – \$0.10) * (19/20) – \$9.50 * (1/20) = -\$0.095 (or more simply the \$0.0 EV of the bet minus (19/20) * \$0.10).  Whereas the buyer only pays the expiry fee 1 time in 20, so his return is his \$0.0 EV minus (1/20) * (\$0.10), or -\$0.005.

So starting with an even bet, the in-the-money expiry fee costs the buyer of a longshot 0.5c per lot and the seller 9.5c per lot – quite a difference!  The ratio varies smoothly from splitting the juice for a 50/50 bet to having the seller pay almost all of it for a 99/1 bet, yet I don’t see any underlying mathematical reason why this should be the case.  Which means it will distort prices.

The same is true of point 3.  If the risk-free rate of return is 5%, and traders are earning 3% on their accounts, then any money locked up costs 2%/year.  For a contract with 100% margin requirements, which is currently the case for the markets on the presidential primaries, this means that staying in a contract for 3 months costs roughly 0.5% of interest.  The seller of a contract at 5 must lock up \$9.50 / contract, while the buyer only has to lock up \$.50.  Which means the seller pays 4.75c in foregone interest while the buyer pays 0.25c.

About the only good thing I can find to say about this fee structure is the consistency – both of these charge buyer and seller at exactly the same rate, namely in proportion to the odds (19:1 for a contract at 5).  Although from the exchange’s point of view, a fixed fee per lot has the benefit of making revenue predictable (as opposed to charging a percentage of winnings), and there are psychological benefits to charging the winner.

Any suggestions for alternate fee structures?

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## The Hidden Complexity of Wishes

"I wish to live in the locations of my choice, in a physically healthy, uninjured, and apparently normal version of my current body containing my current mental state, a body which will heal from all injuries at a rate three sigmas faster than the average given the medical technology available to me, and which will be protected from any diseases, injuries or illnesses causing disability, pain, or degraded functionality or any sense, organ, or bodily function for more than ten days consecutively or fifteen days in any year…"
— The Open-Source Wish Project, Wish For Immortality 1.1

There are three kinds of genies:  Genies to whom you can safely say "I wish for you to do what I should wish for"; genies for which no wish is safe; and genies that aren’t very powerful or intelligent.

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## Aliens Among Us

If you simply assume that everything around you is just like the few things you have seen up close, you may not notice clues that some things are very different.   This applies to the sex lives of your neighbors, and to alien biology.  On the aliens, Paul Davies in the November Scientific American

Thirty years ago the prevailing view among biologists was that life resulted from a chemical fluke so improbable it would be unlikely to have happened twice in the observable universe. … In recent years, however, the mood has shifted dramatically. … Biochemist Christian de Duve called life … "almost bound to arise" on any Earth-like planet. …

How can scientists determine which view is correct? The most direct way is to seek evidence for life on another planet, such as Mars. … An easier test of biological determinism may be possible, however.  … If life does emerge readily under terrestrial conditions, then perhaps it formed many times on our home planet. To pursue this tantalizing possibility, scientists have begun searching deserts, lakes and caverns for evidence of "alien" life-forms-organisms that would differ fundamentally from all known living creatures because they arose independently. …

At first this idea might seem preposterous; if alien organisms thrived right under our noses (or even in our noses), would not scientists have discovered them already? It turns out that the answer is no. The vast majority of organisms are microbes, and it is almost impossible to tell what they are simply by looking at them through a microscope. … Researchers have classified only a tiny fraction of all observed microbes.

To be sure, all the organisms that have so far been studied in detail almost certainly descended from a common origin. … But the procedures that researchers use to analyze newly discovered organisms are deliberately customized to detect life as we know it. These techniques would fail to respond correctly to a different biochemistry. If shadow life is confined to the microbial realm, it is entirely possible that scientists have overlooked it.

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## Leaky Generalizations

Followup toTerminal Values and Instrumental Values

Are apples good to eat?  Usually, but some apples are rotten.

Do humans have ten fingers?  Most of us do, but plenty of people have lost a finger and nonetheless qualify as "human".

Unless you descend to a level of description far below any macroscopic object – below societies, below people, below fingers, below tendon and bone, below cells, all the way down to particles and fields where the laws are truly universal – then practically every generalization you use in the real world will be leaky.

(Though there may, of course, be some exceptions to the above rule…)

Mostly, the way you deal with leaky generalizations is that, well, you just have to deal.  If the cookie market almost always closes at 10pm, except on Thanksgiving it closes at 6pm, and today happens to be National Native American Genocide Day, you’d better show up before 6pm or you won’t get a cookie.

Our ability to manipulate leaky generalizations is opposed by need for closure, the degree to which we want to say once and for all that humans have fingers, and get frustrated when we have to tolerate continued ambiguity.  Raising the value of the stakes can increase need for closure – which shuts down complexity tolerance when complexity tolerance is most needed.

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I like betting on elections, both because it is fun, and because the chance to profit from them helps distract me from the depressing farce of democracy (a mechanism with some decided disadvantages).  Last election I mostly sold Dem Sweep contracts (Dems win House, Senate, and Presidency), plus the tails of the electoral vote distribution.

In both cases, I thought (without actually finding data to confirm it) that the parlay was fairly independent, and the prices were way out of line from that.  The tails of the vote distribution were much fatter than you’d expect if the states were independent, and DEM.SWEEP was priced around 4-8 when the independent probability was 1/2% based on the prices for House, Senate, and Presidency.  It worked well for me, but since I was selling longshots, that one data point means very little.

But now it’s time to gamble some more, so I wired \$20K to InTrade this morning.  Now I need to find something to bet on.  (Have I mentioned I’m a degenerate gambler? ðŸ™‚ ).  My current favorite bets are going long GOP (it’s way too early for the incumbents to be a 2:1 underdog, especially when we don’t even know the candidates!) and shorting Ron Paul (it’s a good bet and a hedge!).  I’d love to hear thoughts from y’all about what bets you like.

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## Not for the Sake of Happiness (Alone)

Followup toTerminal Values and Instrumental Values

When I met the futurist Greg Stock some years ago, he argued that the joy of scientific discovery would soon be replaced by pills that could simulate the joy of scientific discovery.  I approached him after his talk and said, "I agree that such pills are probably possible, but I wouldn’t voluntarily take them."

And Stock said, "But they’ll be so much better that the real thing won’t be able to compete.  It will just be way more fun for you to take the pills than to do all the actual scientific work."

And I said, "I agree that’s possible, so I’ll make sure never to take them."

Stock seemed genuinely surprised by my attitude, which genuinely surprised me.

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## Interpreting the Fed

Here’s a puzzle.

For the first time ever, yesterday at 2pm the Fed released its forecasts for inflation (and other variables) for the next three years.  How should one interpret an inflation forecast for 2010?  Surely this is a statement of what the Fed thinks the “long run” looks like.  Thus, the 2010 inflation forecast – of 1-3/4 percent – is essentially an articulation of the Fed’s inflation target (or at a minimum, its definition of effective price stability).

Now imagine that you are trying to price long-term bonds.  Surely an articulation of the Fed’s inflation target is the most important news all year, if not in several years.  (And surely it is more important than trying to discern whether the short-run forecasts suggest an easing next month, or the month after.)

But markets thought this completely uninteresting.  Take a look at the bond market response:

Of course, markets wouldn’t respond, if they already knew that this is the Fed’s inflation target.  But I’m not so sure this is accurate.  The Philly Fed’s latest Survey of Professional Forecasters suggested  that the expected inflation target was a bit lower (1.6%), and previously Chairman Bernanke had suggested a “comfort zone” of 1-2%

Even if the markets already understood the Fed’s target then surely the announcement of yesterday’s news at least removed substantial uncertainty, which should have – but didn’t – change the risk premium built into the relative pricing of nominal relative to inflation-indexed bonds.

I am left to conclude that markets are either under-reacting to truly important news, or they are truly prescient and already knew the Fed’s inflation target.  My bet is on the former.

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## Merry Hallowthankmas Eve

In a Time oped titled "Merry Hallowmas", Nancy Gibbs complains that corporations are forcing a longer holiday season on us, for nefarious reasons:

"A perpetual Holiday," George Bernard Shaw said, "is a good working definition of hell." This year the perennial ruckus over little girls’ slutty Halloween costumes was still going strong even as the perennial ruckus over the War on Christmas began. It’s as though we’ve supersized our holidays, so that they start sooner, last longer and cost more, until the calendar pages pull and tear, and we don’t know which one we are meant to be celebrating. …

August is the rare month with no shared celebration in it, when we gasp along for weeks on end without collective permission to overspend, overeat and overindulge.  Given that hardship, retailers seize the opportunity. Now it’s not only school that starts the day after Labor Day; so does Halloween. Target and Wal-Mart had their spooky gear out by the following weekend. Monthly magazines do Halloween in the September issue, so Christmas can hit in October.

Sorry, I don’t see a conspiracy of thugs beating up retailers who refuse to join a holiday campaign.  Instead, I see a vigorous competition among retailers trying to attract customers who want a longer holiday season.  Complaining that retailers force a long holiday season makes no more sense than saying studios force violent movies, or that newspapers force horse-race style election-coverage.  Retailers, studios, and newspapers mostly just anticipate consumer demand for such things.  If you want someone to blame, stand in a crowd and look around.

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## Truly Part Of You

A classic paper by Drew McDermott, "Artificial Intelligence Meets Natural Stupidity", criticized AI programs that would try to represent notions like happiness is a state of mind using a semantic network:

STATE-OF-MIND
^
| IS-A
|
HAPPINESS

And of course there’s nothing inside the "HAPPINESS" node; it’s just a naked LISP token with a suggestive English name.

So, McDermott says, "A good test for the disciplined programmer is to try using gensyms in key places and see if he still admires his system.  For example, if STATE-OF-MIND is renamed G1073…" then we would have IS-A(HAPPINESS, G1073) "which looks much more dubious."

Or as I would slightly rephrase the idea:  If you substituted randomized symbols for all the suggestive English names, you would be completely unable to figure out what G1071(G1072, 1073) meant.  Was the AI program meant to represent hamburgers?  Apples?  Happiness?  Who knows?  If you delete the suggestive English names, they don’t grow back.

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