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Fee structure distorts the market

Hi, others have alluded to this, but I haven't seen anyone come out and say it directly.  The current fee structure prevents this market from functioning properly.  Ask any economist, if you have a 10% take on profits and a 5% withdrawal take, you are going to influence behavior.  In this case, it has the effect of preventing most arbitrage, because gross spreads on trades have to be extremely large for it to make economic sense to put money on this site to do an arbitrage.


I get that the site is non-profit, and there are real costs to running it (for the record, I would not be against a profit for the site).  That said, I don't understand though why there isn't a subscription option for users, as it would eliminate the effects the fees are having on the market, which would create more realistic odds (assume that is academic purpose?) as well as a better experience for users.


A few examples specific examples:


a) The current Republic nomination odds are a joke.  They add up to well over 100% (top 7 alone add up to 139% on the "sell-yes" side of market right now, which is the easiest way for me to think about it, all 21 add up to something like 180%).  Let's say I sold 850 shares of each of top 7, that would cost me $4,769.  If none of them wins (not impossible), I make $1,181, or 25% gross.  More likely, one of them wins, and costs me $850, so I really make $331.  That's still 7% gross, and a 10% IRR to the republican convention.  That's a big spread.


In reality though, I'm going to have to pay ~$100 fee on my gross winnings depending on who wins (10% of my gross and I can't deduct the $850 loss I had to take to get here!).  I also have to pay 5% to take the capital back off the site, assuming I didn't want to let it all ride after the arbitrage (that's another $250-ish based on my 4,768 + ~$230 gross gains).  That is all my winnings.  I have a 7% guaranteed gross trade, and I can't make any money on a net-basis.  This is why the odds don't make any sense on the site, because the fees prevent arbitrage. 


b) Just to point out that this isn't the only place where such a discrepancy exists, Hillary + Bernie odds for winning the general election right now are 69% on the offer side, despite democratic odds of winning presidency at only 61%.  This is a huge spread for a normal market, but when you consider you'll be taxed on profitable trades, without an offset for losses, it's not very interesting.  


I could go on - you will notice nearly every question has odds that currently add up to well over 100%.  No one can take advantage of this because no one wants to add too much capital to the site since they're going to get hit with a 5% cut across the board to remove it later.  


Again, I want to be clear I am all for the site making money, but how it is structured today is influencing the odds and distorting the market in obvious and illogical ways.  For sake of argument, let's say site was willing to allow users to opt in to an alternate $350/yr subscription rate as the only fee (which seems very high for most users, but is in line with the fees generated from the trade above).  Who wants to bet that the spreads above would collapse within days?  I think it would meaningfully improve efficiency/accuracy of the market odds, and would still allow plenty of room for a very nice business margin/model for the operators and I'm guessing most users of the site would happily opt in at a more reasonable price point (maybe ~$100/yr?) although I'd love to hear others' thoughts or opposing viewpoints.




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In reading the policies (and forming a rough idea of what their business model is) it has become painfully obvious what it is about: recruiting squares.


Fish, general population, whatever you want to call them, that's who Predictit wants to participate. It's sad because if Predictit implemented a free-withdrawal policy they would get so much more business the 10% on profits alone would be greater than the current 10% on profits + 5% on withdrawals dumpster-fire that is their current operation. 


The stated policy is that the fees are necessary to keep the site running. I'd be excited to see those numbers and how much in fees are being collected and how they're used.


If I sound bitter, I'm not, I think they have a great product/business I'm just disappointed their fee policy is so abysmal that otherwise potential customers would be adamantly turned away.

robcummings:


How would a deposit fee be better than a withdrawal fee? The only difference is that you would have less margin to play with in the mean time. This doesn't reduce expected ROI, but it does reduce expected trading volume. The incidence of the fee on "winners" vs "losers" doesn't change much based on when you charge it. It's not a all clear to me how changing when the fee is assessed would change any market distortions associated with it.

mahany25:


First off, your calculation of fees on 10% profit is wrong. The current system bases fees on GROSS profits, which is my main problem with it. Your calculation is for what fees would be assessed on NET profits. Read my posts above. 


So, if you buy Clinton No at 10 and Sanders No at 80 (the market is no longer this overbid, but I'm using your 90 combined price), then you feel will be depend on who wins. If neither wins, that's great, you win 90 on clinton no shares and 20 on sanders shares, and get charged fees of 9 and cents per share. Yippee.


If Clinton wins, you lose your 10 cent investment in each of those, but win 20 on each Sanders, for a 20 cent Gross profit. You are charged 2 cents per share, so your net profits after fees are 8 cents per share.


If Sanders win, you make 90 cents cents per share on your Clinton No position and are charged 9 cents per share in fees. On Sanders, you lose 80 cents per share, Your net profit per share is 90-9-80=1 cent per share. If you had to pay 85 for those Sanders No shares, you would have lost 4 cents per share, even though you bought them for a combined 95 cents.


This is why I think they should move to fees on NET profits, even if it requires a significantly higher percentage.


As for your calculation on the 5% fee, that assumes you only use funds for one bet before withdrawing. Why assume that? It seems like arbitrage-inclined traders are precisely those that should be expected to roll funds over into new markets once one markets resolves itself or prices get bid to more reasonable levels. I know I certainly don't plan to pull all my money out after nominations are resolved. You only pay the 5% once, so the impact of the fee on any particular market hard to tease out. If the fee will probably make me more reluctant to to pull money out and after the general election and instead look for markets to trade until the next election cycle, as opposed to pulling my money out and then having to pay the 5% again. As I've said before, if this fee can be reduced (including via alternative deposit options), that's great, but the fee on GROSS profits is a much bigger problem.


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The current fee structure is not that big a deal for small investors that are not serious. What I would suggest a fee structure that would include : a) say 10% of all money you deposit b) Another 10% of all money you take out of the system. That way there are no trades. I would also point out that the house keeps the float. Basically the money the house holds can be easily invested conservatively and earn money. If the markets get bigger, that ought to be enough to run the entire system very profitably. The problem with relying on float, it make fees for longer term bets rather high. I think it may be more profitable in the long run for the site to have lower fees. Longbets.org allows folks to make bets in terms of a mutual fund so that is less of an issue. The in/out fee structure i proposed above would still work. Another approach would be to take a small percent of all instruments being held each month Another potential fee is to allow folks to pay to get claims created. I think folks like insurance companies might do that to evaluate risk important to them(they might even subsidize trading to get the market going)
You might consider giving traders an option in how their fees are paid. I would much rather pay a percent up front and and a percent when I take money out than the current structure of 10% of the profit.I think having low friction traders would help make the markets more lively and reduce distortion. Long run we need to get enough liquidity here the fees can be low and markets can trade more likey real investments.
The withdrawal fee should not exceed the cc processesing fee for deposits plus a small check fee at most. I've made over $14k profit above the 1.35k I put on which means I'm already paying a withdrawal fee equivalent to half of my starting bankroll....wow.

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 @gabeweil: The deposit fee differs from the withdrawal fee in that winners would no longer subsidize losers. Everyone buys their way in instead of winners paying the withdrawal fee the losers aren't paying.

I think the current structure works well if we assume the fundamental purpose of the enterprise is to get people to participate in the market for the long term (which diminishes the burden of the withdrawal fee relative to a subscription or transaction fee), and to ultimately commit to an actual prediction. 


For example, right now I have a trade set up that works out to a 1.2% profit (after profit fees) in the most likely outcome, and between a .5% and -.5% result for the rest of the non-extraordinary outcomes. So it's roughly as good as a mediocre bank account.

But, if I'm willing to commit to a predicted outcome and unwind some of my hedges a bit early as the deciding event gets closer, the result improves dramatically - putting my likely (after profit fees) outcome somewhere in the +20% range. Assuming I'm right in deciding which hedges to unwind, of course. Which is the point of the whole enterprise - to get people to try really hard to be right.

With some plausible assumptions, the incidence of fee is not significantly affected by whether it is a deposit fee or a withdrawal free.


Basically, if you assume constant returns to scale (positive or negative), then you shouldn't care when the fee is assessed. It's the same illusion people suffer from in choosing between a Roth IRA and a conventional IRA. If you have positive returns, you pay a larger $ amount in taxes if you pay on the back end, but all that matters in terms of the end result is the rate you pay.


For example, if you deposit $1000 and double your money, it doesn't matter whether you pay 5% ($50) up front, or 5% ($100) on the back end. Either way you end up with $1900. The same goes for someone who loses half their investment. Using the same $1000 initial deposit, they would end up with $475 regardless of they pay $50 up-front or $25 upon withdrawal.


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It's true that it's not about winners subsidizing losers. However, disincentivizing people from leaving and not disincentivizing people from joining is going to make it so there's more people on the site. I might not have joined if the fee was for deposit.

I think clahey is probably right, but moving the fee to deposits is only a (greater) disincentive to join because of people falling for a cognitive illusion. If there's a few on withdrawals, you're effectively committing to pay it when you deposit. The only ways to avoid paying the fee and losing all your money or leaving your money on the site forever, neither of which constitutes meaningful fee avoidance.

Another point is that the limit of $850 on any particular trade means that even with market linking, any one arbitrage agent can only help balancing a market so much.


Even if a market is off enough that you can make money after the 10% cut on gross profits by shorting all the stocks, you can still only invest in it until you've invested $850 in the least likely candidate.

clahey:


That's true, but the $850 was a compromise needed for regulatory approval / forbearance, so it's not something that's likely to be changed. 



Yeah, I understand about having the $850 limit, I just wish it was an $850 limit on the linked market. As it is, I have negative risk in a market and I still can't invest more.


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I think that all profits should be assessed at time of withdrawal.


Others have pointed out the distorting effects of charging a fee on gross, rather than net, profits. For a single market. Changing from net to gross would have the desirable effect of enabling arbitrage within a linked market. However, there still is no possibility to arbitrage or hedge bets between markets. 


For example, if I think that the implied odds of Bernie winning the presidency given that he wins the nomination are too high, I should be able to take out a 'yes' position on Bernie-nomination and a 'no' position on Bernie-Pres, in effect betting that he will be nominated and will lose the presidency. However, owing to the fee structure, this becomes a very unfavorable proposition.


It should work like this: at time of withdrawal, current funds are evaluated. If you are above your initial deposit(s), then you pay a high rate (25%?) to withdraw any profits, and then the lower 5% rate to withdraw any further amount. This way, your losses get amortized and if you make many +EV bets, even slightly (<<10%), you can make money in the long run.


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