"GEOPOLITICAL RISK — uncertainty about war, terrorism or political developments — can be very hazardous to your portfolio’s health.
Fortunately, modern financial markets have developed innovative new
products to help hedge geopolitical risk. Now you can trade futures
contracts on who the next president will be, whether or not the U.S.
will bomb Iran, whether Hamas will diplomatically recognize Israel,
whether Osama Bin Laden will be apprehended, and many more.
But this week some investors learned that this particular
financial innovation carries special risks all its own — as one of
these geopolitical futures markets blew up right in their faces.
The blow-up happened in the market for futures contracts on
whether North Korea would test a long-range missile. That’s just what
Kim Jong Il’s totalitarian regime did on July 4, raising tensions
throughout the region and triggering a 6% drop in the Tokyo stock
market. Anyone who bought the futures contracts should have had a big
payday. But that’s not the way it turned out. Those investors ended up
losing 100% of their money.
The big payday came for those who took the wrong side of the
trade. Even though North Korea did test its missiles, those who bet
that it wouldn’t are the ones who made all the money.
These futures contracts trade online at Tradesports,
a web site based in Dublin, Ireland, that offers trading in all manner
of sports, political and geopolitical events.
Understand what happened here: The North Koreans launched their missile, but Tradesports was unable to officially confirm that with the U.S. DoD. That’s a rookie mistake, and it certainly would make me uncomfortable risking real cash with a firm with such a silly management team in place.
Kudos to Chris Masse
— one of prediction markets biggest fans — for going postal on
Tradesports for their bad judgement. (If you are interestedin the
subject, then definitely read Masse’s full post here: TradeSports / InTrade’s North Korean Missile Contract),
As I’ve said before, I do rely on markets as part of my modelling, and as a forecasting tool: Anytime you look at a trend, or an inverted yield curve, or the yield on a 10 year treasury bond, or the tips spread, or the relative performance of the Transports to the Dow, or any combination of traded items as a tool, you are using the tools of prediction markets.
My overriding issue (of the many I have with them) is that they are too thinly traded, and there is not enough money being traded for them to be reliable. Or, they are trying to determine issue inknowable by the participants who are voting/betting.
Now, you can now add another problem: Tradesports management has commited a managerial faux pas. Their hyper-technical definition of "launched" would never be tolerated by markets such as the Treasury, NYSE or even Nasdaq.
That’s pink sheets material, buddy.
TradeSports / InTrade’s North Korean Missile Contract
Chris. F. Masse
The Journal of Prediction Markets
Tradesports’ Bad Call
Ahead of the Curve
Smart Money, August 4, 2006