Saturday, August 12, 2006

Odds on Castro Coming Back to Power

I'm a big fan of predictions markets, since they have applications to so many areas. I hadn't realized (but I should have known) that Tradesports has started trading in a contract based on whether Fidel Castro resumes the presidency of Cuba by August 31.

For those who aren't familiar with Tradesports (and predictions markets in general), this contract pays $1 if the event covered comes to pass, and $0 otherwise.

The "fair" price for a contract like this is the probability that the "payoff event" would come to pass. As an example, let's assume that there was a 30% chance of Castro resuming power. If you bought the contract, you'd have a 30% chance of receiving $1 and a 70% chance of receiving $0. So, your expected payoff would be 0.30($1) + 0.70($) = $0.30, or 30 cents.

When the contract started trading on August 4, it was selling at about $0.70 cents - it's now around $0.30. This indicates that the traders in the Tradesports contract assume that there's about a 30% chance of Castro resuming power. Here's a graph of the prices in the contract, in case you're interested (click for a larger image).

HT: Marginal Revolution.

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