Buy Insurance -- Bet Against Yourself

by MBlume 9y26th Nov 201069 comments

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My friend and housemate, User:Kevin, makes a very pleasant living selling opioids on the internet, a living he expects to continue for some time, unless something awful happens like Obama losing the next election. The Intrade contract for Obama's loss is currently trading at 42% -- what can User:Kevin do about this?
My suggestion was that he bet heavily on Obama's loss. Say he spends $4200 buying not-Obama futures. If Obama wins, that money becomes worthless, but he gets four years selling kratom regulation-free. On the other hand, say Palin takes a surprise victory and institutes draconian regulation on various substances -- User:Kevin's $4,200 has just become $10,000, leaving a $5800 windfall to help him while he finds his next muse.
This is nothing more than what we normally call buying insurance, just extended to whatever outcomes you may want to insure against. Let's talk about some of the effects of this action.
Leaving a Line of Retreat
Let's say that User:Kevin now finds Obama's loss more or less unthinkable (I don't mean to impugn his rationality -- the article's more or less fictional from here on). Well, that's not really very good -- he  needs  to think about it. I suppose the proper answer is something like "If Obama will win the election, I want to believe..." -- but it may  also  help to think that, yes, a Republican win would suck, but it would also come with this huge financial windfall up front. That is, by flattening your outcome curve a bit, you can  reduce your attachment to individual outcomes, and help yourself to make more rational judgments.
Of course, if the market gives Obama 60%, User:Kevin should probably just believe that. That's what markets are for. Which brings us to:
Helping the Market
You might think that User:Kevin's (hypothetical) actions are antisocial. That by buying not-Obama futures, he's sending a false signal to the market decreasing Obama's chances. If so,  Robin Hanson might like to have a word with you. Here's why:
Let's say that Clippy is a rational speculator in this market. He doesn't care whether Obama wins or not, he just wants to maximize his monetary outcome so that he can purchase materials with which to create paperclips. Let's further say that the market is filled only with rational speculators like Clippy.
Well, based on the family of no-bet theorems, they will all expect that the best-informed actors in the market will make their money from the least-informed actors. Half of them will conclude that they are the least informed, and choose not to play. Eventually those speculators best equipped to find good information and make good speculations will be alone in the market, with no one to bet with, and no incentive to produce good information. Market volume drops, put/call spreads widen, everyone goes home, no one gets informed.
Now let's bring lots of noise to the market: irrational actors convinced they know better than the going rates because their star sign told them so; agents of one political party or another intentionally manipulating the market to energize their base; rational insurance-buyers who (may) have good probabilities, but have skewed valuations on money and are willing to accept above-or-below optimal prices. Now there is money in the market. Now there are buy and sell orders from all sides. Now it  makes sense  for Clippy to spend  lots  of computing cycles running regression tests on past electoral outcomes, buying and selling whenever the advantage is to him, making lots of money, and  pricing the market accurately. Volume shoots up. Spread goes down. Prices move near-instantly with good information. Everyone is informed.
For all these reasons, gentle readers, I urge you to wire some money into an offshore account, log into intrade, find some outcome that would make you miserable, and bet heavily on it.

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