Iowa Electronic Markets

From Wikipedia, the free encyclopedia
How it works
Here are examples of contracts that the IEM traded, beginning June 6, 2006, concerning the 2008 US Presidential Election Winner-Takes-All Market. (The contract descriptions came from the IEM site.)
DEM08_WTA
$1 if the Democratic Party nominee receives the majority of popular votes cast for the two major parties in the 2008 U.S. Presidential election, $0 otherwise
REP08_WTA
$1 if the Republican Party nominee receives the majority of popular votes cast for the two major parties in the 2008 U.S. Presidential election, $0 otherwise
On the first trading day in January, 2007, the DEM08_WTA contract sold for 52.2 cents.
At this point, a speculator has a number of options.
1. He can simply buy a number of DEM08_WTA shares and wait for the results of the election. If the Democratic Party nominee receives the majority of popular votes in the 2008 Presidential Election, the speculator would have his contract liquidated and receive $1, for a profit of 48¢. If the Democratic Party nominee did not receive the majority of popular votes in the Presidential Election, then the speculator would receive nothing.
2. Alternatively, he could have bought shares intending to sell them later (before the election and the resolution of the share values) for a greater amount.
3. Another option would be to essentially short sell DEM08_WTA shares - if one considers the price of DEM08_WTA to be too high and incommensurate with the true probability of the popular vote going to the Democratic nominee, one can buy a "bundle" for $1. In this case, the bundle would be 1 DEM08_WTA and 1 REP08_WTA; the value of these two shares is guaranteed to be 1$ (as they will be cashed out as either worth $1 and $0, or $0 and $1). Hence to short sell, one would buy one bundle and then sell the overvalued items.
4. It is possible that a given market is simply irrationally priced. If the price of all the different shares is greater than or less than $1, then there is at least one share which is not correctly priced and so can either be shorted or gone long on. The price can be seen as the probability, and it doesn't make sense to have a total probability of greater than 100, and the markets are designed to cover all possibilities, so less than 100% doesn't make sense either. This is not necessarily true of all markets; in the Winner takes all markets this is true, but it is possible for the total value of 1 of every contract, which in 08_WTA is guaranteed to be $1, to exceed $1, such as in the markets dealing with share prices.
The IEM also trades futures based on financial markets, such as whether the Fed Funds rate will be raised at the following meeting.
[edit] Rules and limits
The IEM is not regulated by the CFTC (Commodity Futures Trading Commission) or any other agency. Because of the small sums wagered and the academic focus, the IEM has received two no-action letters that extend no-action relief. A speculator may put at risk in the IEM only between 5 and 500 USD. In contrast, other future markets like HedgeStreet are regulated by the CFTC and allow speculators to take on or offset financially significant amounts of risk regarding economic events or the prices of commodities.

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