Inefficient Markets

I just took a look at the bid-side markets on Intrade for the Democratic nominee for Vice President. Here are the levels (for those names with bids above zero):

Tim Kaine – 30.1
Evan Bayh – 26
Kathleen Sebelius – 16
Joe Biden – 10
Brian Schweitzer – 5.5
Hillary Clinton – 5
Sam Nunn – 4
Jack Reed – 4
Anthony Zinni – 4
Al Gore – 3.5
Ed Rendell – 3.5
Wes Clark – 3.2
Chuck Hagel – 3
Janet Napolitano – 3
Bill Richardson – 3
John Edwards – 2.8
Chris Dodd – 2.5
Dick Gephardt – 2.2
Claire McCaskill – 2.2
Michael Bloomberg – 2
Bob Graham – 2
Mark Warner – 1.7
Tom Daschle – 1.2
Bob Casey – 1
Barack Obama – 1
Ted Strickland – 1
Tom Vilsack – 1
Bob Kerrey – 1
John Kerry – 0.6
Caroline Kennedy – 0.5
Jim Webb – 0.5

That adds up to 147. Say you take that bet for $1 per unit – you’re out $100 if you short a name and that person is picked. I don’t know the margin rules, but let’s assume that if you short the whole list you have to put up the maximum you could have to pay out – which is $100, since only one name can possibly pay out. That means you can short the entire list and immediately take home $47 risk-free – with the potential to make an additional $100 if a really dark horse like, say, Bill Bradley or James Jones turns out to be the nominee.

Or suppose you think Evan Bayh’s going to be the nominee. You short everybody but him, and take home $21, no money down (the $100 margin comes out of receipts on the other trades). If either Bayh or a dark horse gets picked, you get an additional $100, for a total profit of $121. By contrast, if you bought Bayh, you’d put down $29.9 for a chance to receive $100 if you’re right.

Or suppose you think one of the top four contenders is going to get the nod – Kaine, Bayh, Sebelius or Biden. To buy all four, you’d need to pay a total of $93.80. But if you just shorted everybody else, you’d receive $64.90. Assuming you have to put up $100 in margin, you’re putting down a net $35.10 with the potential to receive $100 – or, better, $35.10 with the potentially to earn $64.90, nearly a 2-for-1 payoff – versus putting down $93.80 to potentially earn $6.20. Why would anyone play the long side when you can put the same bets on for such better odds on the short side?

There must either be some very screwy margin rules, or there must be absolutely no liquidity. Either way, the existence of a substantial apparent arbitrage like this suggests that these markets should not be taken too seriously as a guide to what “smart money” thinks about the odds of anything.