The CDS market vs. Paddypower October 6, 2013 at 6:16 pm

From the Paddypower website:

Congress

From the CDS market:

Congress

Wot, an arbitrage? Well, OK, there might be an issue in doing big enough size on PaddyPower, I agree, but hey, I do like the idea of buying cheap CDS protection then hedging by selling on a political betting website.

3 Responses to “The CDS market vs. Paddypower”

  1. Could you please tell me how should I read these PaddyPower quotes, and what are the mechanics of the transaction? I’m more familiar with the mechanics of Intrade, which has been shut down by the CFTC.

  2. Odds are quoted based on getting your stake back, so here if you invest 2 in betting that the US will default, you get 11 (9 plus your 2 stake) back if it does. Similarly if you sell the bet, you invest 8 and get 9 back if the US doesn’t default. The spread in probability terms is therefore 11.1% at 18.2% corresponding (roughly – I can’t be bothered to do the daycount and constant hazard rate calculations in full) to annualized PDs of 2.8 and 4.5%. Strictly the bet is a digital CDS as its payoff is independent of recovery, so you would get screwed if there is a technical default but the payoff on the CDS is minimal.

  3. Bingo. This can’t be a true arbitrage because you’d at least need to factor in the recovery swap. It wouldn’t be at all surprising to me for the US recovery fixing to end up par.