Find another prediction market, or another person, willing to make the bet with you at the true (1%, say) odds. Then you buy one and hedge by selling the other. Arbitrage usually requires two different bets.
For instance, if you sell the Intrade prediction, but make a $1 bet at 99:1 odds that Paul will win the Republican nomination (god forbid), you win $3.50 - $1.00 when Paul loses, and $99.00 - $96.50 when he wins.
Another approach is to diversify. This is in fact how arbitrage is often used by hedge funds and the like—they attempt to identify many such opportunities which they believe (hope) are uncorrelated and spread their bets across them. On average they expect to make a positive return and they also are protected against the occasional low probability large loss. If they turn out to be wrong in their assumption of the various bets being independent you get an LTCM.
I used the word ‘strong’ to emphasize one of the meanings of the word ‘arbitrage’. I’m not going to pull out my OED on you, but the strong definition of arbitrage is not the only definition, and isn’t even the most common use. Look at Wikipedia & Wiktionary; look at Google News or Google Books.
It’s fine to clarify what definition is meant when discussing technical details where that matter. To insist on only one definition in every use of the term is the sheerest fanaticism, nonsense on stilts, and merits every downvote it receives.
Is there no value in defending the definition of a word? Arbitrage originally meant expected profits with zero risk of loss. Now some people say they also want to use it to mean expected profits with non-zero risk of loss. Okay, then why not just say “expected profits” (or “edge” as traders would call it) since you’ve eliminated the distinction that makes the term meaningful in the first place? I mean, would you say that the AGI I’m building in my basement is “Friendly” just because I expect it to do good things, even though it also might paperclip the universe 2% of the time?
Pure arbitrage pretty much never exists. There is almost always non-zero risk of loss. Arbitrage transactions invariably have some execution risk, though with very liquid markets and electronic trading it may be arbitrarily small. Generally the liquid markets with the fastest trading are those that will offer the least arbitrage opportunities though so in reality greater profits almost always come at the cost of increased execution risk. It doesn’t seem a huge stretch to extend the concept to statistical arbitrage—you’re never really going from zero risk to risk, you’re just increasing from a very small risk to a larger risk and going from very reliable price correlations to less reliable ones.
There is value in clarifying which definition is being used. That is, I hope, what I’ve been doing here, in opposition to the notion that there is only one sense that can be used and so any clarification is nonsense.
And while strong arbitrage is nice in having 0 risk as opposed 0.1 risk or 0.11 risk, we experience no trouble in real life because some words can be made to overlap despite their average & typical uses. Expected profits or edges don’t necessarily cover the same mental ground; if I buy and hold indexes for 50 years, I might expect a profit, but few would call that arbitrage.
“The sense of a sentence—one would like to say—may, of course, leave this or that open, but the sentence must nevertheless have a definite sense. An indefinite sense—that would really not be a sense at all. - This is like: An indefinite boundary is not really a boundary at all. Here one thinks perhaps: if I say ‘I have locked the man up fast in the room—there is only one door left open’ - then I simply haven’t locked him in at all; his being locked in is a sham. One would be inclined to say here: ‘You haven’t done anything at all’. An enclosure with a hole in it is as good as none. - But is that true?”
What you’re doing is purposefully diluting the word. “Arbitrage” as a word exists to talk about riskless profit. You’re trying to introduce risk to it, to what end?
You know, the first definition in the OED doesn’t even have anything to do with finance—it’s simply the decision of an arbitrator. The second is ‘exercise of individual judgement’. Only the third includes the commercial definition, and that (and its quotes from the 1800s on) speaks only of buying and selling in geographically disparate areas. Nothing about risk. Indeed, the 1882 quote goes ‘He cannot tell what the outcome will be… of this unfathomable arbitrage business.’
‘Arbitrage’ did not begin as the strong definition. It did not exist as finance at all. The strong definition is a 19th and 20th century technical addition to a word imported from the French. I am purposefully diluting it? How can I dilute something which was never pure to begin with?
Again, explain whether you are speaking descriptively or prescriptively when you say ‘arbitrage exists to talk about riskless profit’. If the former, you are manifestly wrong and have been wrong for the last 600 years according to the OED. If the latter, then why should we abandon all the other meanings?
You’re right—arbitrage as a word doesn’t exist to talk about riskless profit. Arbitrage as a financial term, however, exists to talk about riskless profit.
You’re right—arbitrage as a word doesn’t exist to talk about riskless profit. Arbitrage as a financial term, however, exists to talk about riskless profit.
It would seem that taw was using the more general meaning and not the financial term.
I mean, would you say that the AGI I’m building in my basement is “Friendly” just because I expect it to do good things, even though it also might paperclip the universe 2% of the time?
If that is a once off 2% chance of failure then I’ll go with it and call it Friendly Enough For Me. Come to think of it I may be tempted by 2% per 1,000 years.
Come to think of it I may be tempted by 2% per 1,000 years.
I’m virtually certain that you realize the implications; for instance, you’re saying you’re tempted by a 50% chance of paperclipping per 34,000 years. I’m less clear on how you could justify being tempted.
I’m virtually certain that you realize the implications; for instance, you’re saying you’re tempted by a 50% chance of paperclipping per 34,000 years. I’m less clear on how you could justify being tempted.
Start with assigning a very low probability on something better occurring. Then discount somewhat the extremely good options where you live billions of years, not valuing years on a linear scale. Then consider what you can do in 10,000 years with a super-intelligence backing you up. For example, it could build you a relativistic rocket and send you off fast enough that you are outside a future paper clipper’s future light cone. Possibly sending multiple copies of the human race out in various directions and with various planned durations of flight (given that you don’t know when Mostly Friendly is going to go nuts).
I haven’t done any maths on what the figures would need to be for me to actually choose that scenario. That’s why I say ‘may’. It is certainly worth considering seriously.
The Wikipedia article you cite is almost entirely uncited; the Wiktionary entry is clearly wrong. These don’t support your argument. (FWIW, the discussion page of the arbitrage article has several comments along the lines of, “This isn’t arbitrage.”)
Linking to Google search results is basically saying, “Go read a book.” It isn’t an argument; it’s just status posturing. “I don’t have to address your points.” Well, I’ll address them.
Arbitrage is taking advantage of price differences in a market to make riskless profit. To the extent that someone describes a speculation strategy as “arbitrage,” they are trying to sell you something. If I told you something was “a sure thing,” and then it failed, would you change how you think about what “a sure thing” means or would you think, “When he says something is a sure thing, it isn’t always true”?
In general, I think you’re right about not being fanatical about definitions. But what was described, in the article and in the comment, is entirely the wrong use of the word “arbitrage.” Arbitrage is certainly not speculation (about as wrong a use of the word arbitrage as there is). Arbitrage is distinct from hedging, as well. Arbitrage is not a diversification tactic.
So I can’t help but conclude that your “a word can have many meanings” idea is just an applause light. Did I miss your alternative definition, of which mine is a subset, or was I just plain not squishy enough for your taste?
The problem is, what do you mean by the Wiktionary entry is clearly wrong? They seem pretty reasonable to this layman. Do you mean that they do not exclude every meaning including the possibility of loss? By what authority is this open-mindedness ‘wrong’? Did Jehovah in some obscure Numbers passage lay down this rule? Or is it just that you always use ‘arbitrage’ in the no-possible-loss sense, and so it’s incorrect for anyone else to use it any other way?
I hold to a descriptivist view of language; the use of a language is its meaning. If people use arbitrage in senses which allow loss, then arbitrage can mean techniques which allow loss. (Such techniques are a superset of techniques which don’t allow loss, so it’s fair to call the narrower no-loss definitions ‘strong’ definitions, along the lines of the Strong and Weak AI hypotheses, for example.) At that point, all I need to do is show that the other meanings are widespread. Wikipedia has it, and serves it up to ~1,600 viewers a day; Wiktionary probably adds a few hundred hits to that. The Google Books has hits that explicitly point out that they will henceforth use ‘arbitrage’ in its narrow sense; other books simply define it in a broad sense. The News hits demonstrate that the wider meanings are likewise in widespread use. (Your Google search has no relevance, any more than if I had instead said ‘bgrah449 is using the narrow definition of abitrage’, which ironically actually has a non-LW hit.)
But what was described, in the article and in the comment, is entirely the wrong use of the word “arbitrage.”
Long-Term Capital Management, from the popular history books I’ve read on them (and 1 or 2 academic articles long ago), did not believe it was an overall arbitrage. Arbitrages in the risk-free sense were taken when they found them, but much of their business was looking for mismatches which were not risk-free, but which they could exploit with leverage and hedge themselves against. They figured that they could only be killed by century-events or rarer. If they were just risk-free arbitraging, then they could never have been killed; if you can have losses on a risk-free arbitrage, an arbitrage in the narrow sense, then it’s not such an arbitrage, by definition.
Thus, bringing up the strategy of diversification, and LTCM in particular, only makes sense if mattnewport was thinking of arbitrage in the broader sense. (How can 100 risk-free arbitrages across the global economy be any safer than 100 risk-free arbitrages in just the USA? 100 0 = 100 0.) This was my original point: you and Blueberry both seemed (to me) to be discussing narrow/strong arbitrages, and mattnewport was putting forth a broad/weak arbitrage.
So I can’t help but conclude that your “a word can have many meanings” idea is just an applause light.
Ironically, ‘applause light’ can itself be an applause light.
Statistical arbitrage is named thus because over an infinite time period, it is arbitrage.
I don’t think so. I think “Statistical arbitrage” is marketing. As long as there is risk of ruin statistical arbitrage is still risky, even over infinite time. LTCM isn’t going to show a profit ever.
For the benefit of the conversation, and posted without taking a position, here is the OED’s definition of arbitrage:
Comm. The traffic in Bills of Exchange drawn on sundry places, and bought or sold in sight of the daily quotations of rates in the several markets, each operation being based in theory on the calculation known as ARBITRATION of Exchange, q.v. Also, the similar traffic in Stocks, so as to take advantage of the difference of price at which the same stock may be quoted at the same time in the exchange markets of distant places. [In this sense adopted from mod.F., and usually pronounced ({sm}{fata}{lm}bitr{fata}{lm}{zh}).]
Arbitration of Exchange (cf. F. arbitrage in same sense): The determination of the rate of exchange to be obtained between two countries or currencies, when the operation is conducted through a third or several intermediate ones, in order to ascertain the most advantageous method of drawing or remitting bills.
ETA: One needs a subscription to follow those links.
Find another prediction market, or another person, willing to make the bet with you at the true (1%, say) odds. Then you buy one and hedge by selling the other. Arbitrage usually requires two different bets.
For instance, if you sell the Intrade prediction, but make a $1 bet at 99:1 odds that Paul will win the Republican nomination (god forbid), you win $3.50 - $1.00 when Paul loses, and $99.00 - $96.50 when he wins.
[Edited to fix math]
Arbitrage always requires more than one bet, but it usually requires more than two bets.
Another approach is to diversify. This is in fact how arbitrage is often used by hedge funds and the like—they attempt to identify many such opportunities which they believe (hope) are uncorrelated and spread their bets across them. On average they expect to make a positive return and they also are protected against the occasional low probability large loss. If they turn out to be wrong in their assumption of the various bets being independent you get an LTCM.
Hm, but isn’t bgrah449 using the strong definition of arbitrage, where you cannot lose, period?
Strike the word “strong.”
No.
I used the word ‘strong’ to emphasize one of the meanings of the word ‘arbitrage’. I’m not going to pull out my OED on you, but the strong definition of arbitrage is not the only definition, and isn’t even the most common use. Look at Wikipedia & Wiktionary; look at Google News or Google Books.
It’s fine to clarify what definition is meant when discussing technical details where that matter. To insist on only one definition in every use of the term is the sheerest fanaticism, nonsense on stilts, and merits every downvote it receives.
Is there no value in defending the definition of a word? Arbitrage originally meant expected profits with zero risk of loss. Now some people say they also want to use it to mean expected profits with non-zero risk of loss. Okay, then why not just say “expected profits” (or “edge” as traders would call it) since you’ve eliminated the distinction that makes the term meaningful in the first place? I mean, would you say that the AGI I’m building in my basement is “Friendly” just because I expect it to do good things, even though it also might paperclip the universe 2% of the time?
Pure arbitrage pretty much never exists. There is almost always non-zero risk of loss. Arbitrage transactions invariably have some execution risk, though with very liquid markets and electronic trading it may be arbitrarily small. Generally the liquid markets with the fastest trading are those that will offer the least arbitrage opportunities though so in reality greater profits almost always come at the cost of increased execution risk. It doesn’t seem a huge stretch to extend the concept to statistical arbitrage—you’re never really going from zero risk to risk, you’re just increasing from a very small risk to a larger risk and going from very reliable price correlations to less reliable ones.
There is value in clarifying which definition is being used. That is, I hope, what I’ve been doing here, in opposition to the notion that there is only one sense that can be used and so any clarification is nonsense.
And while strong arbitrage is nice in having 0 risk as opposed 0.1 risk or 0.11 risk, we experience no trouble in real life because some words can be made to overlap despite their average & typical uses. Expected profits or edges don’t necessarily cover the same mental ground; if I buy and hold indexes for 50 years, I might expect a profit, but few would call that arbitrage.
--Wittgenstein, Philosophical Investigations, 99
What you’re doing is purposefully diluting the word. “Arbitrage” as a word exists to talk about riskless profit. You’re trying to introduce risk to it, to what end?
You know, the first definition in the OED doesn’t even have anything to do with finance—it’s simply the decision of an arbitrator. The second is ‘exercise of individual judgement’. Only the third includes the commercial definition, and that (and its quotes from the 1800s on) speaks only of buying and selling in geographically disparate areas. Nothing about risk. Indeed, the 1882 quote goes ‘He cannot tell what the outcome will be… of this unfathomable arbitrage business.’
‘Arbitrage’ did not begin as the strong definition. It did not exist as finance at all. The strong definition is a 19th and 20th century technical addition to a word imported from the French. I am purposefully diluting it? How can I dilute something which was never pure to begin with?
Again, explain whether you are speaking descriptively or prescriptively when you say ‘arbitrage exists to talk about riskless profit’. If the former, you are manifestly wrong and have been wrong for the last 600 years according to the OED. If the latter, then why should we abandon all the other meanings?
You’re right—arbitrage as a word doesn’t exist to talk about riskless profit. Arbitrage as a financial term, however, exists to talk about riskless profit.
It would seem that taw was using the more general meaning and not the financial term.
If that is a once off 2% chance of failure then I’ll go with it and call it Friendly Enough For Me. Come to think of it I may be tempted by 2% per 1,000 years.
I’m virtually certain that you realize the implications; for instance, you’re saying you’re tempted by a 50% chance of paperclipping per 34,000 years. I’m less clear on how you could justify being tempted.
Start with assigning a very low probability on something better occurring. Then discount somewhat the extremely good options where you live billions of years, not valuing years on a linear scale. Then consider what you can do in 10,000 years with a super-intelligence backing you up. For example, it could build you a relativistic rocket and send you off fast enough that you are outside a future paper clipper’s future light cone. Possibly sending multiple copies of the human race out in various directions and with various planned durations of flight (given that you don’t know when Mostly Friendly is going to go nuts).
I haven’t done any maths on what the figures would need to be for me to actually choose that scenario. That’s why I say ‘may’. It is certainly worth considering seriously.
Good answer.
The Wikipedia article you cite is almost entirely uncited; the Wiktionary entry is clearly wrong. These don’t support your argument. (FWIW, the discussion page of the arbitrage article has several comments along the lines of, “This isn’t arbitrage.”)
Linking to Google search results is basically saying, “Go read a book.” It isn’t an argument; it’s just status posturing. “I don’t have to address your points.” Well, I’ll address them.
But first: How about this Google search?
Arbitrage is taking advantage of price differences in a market to make riskless profit. To the extent that someone describes a speculation strategy as “arbitrage,” they are trying to sell you something. If I told you something was “a sure thing,” and then it failed, would you change how you think about what “a sure thing” means or would you think, “When he says something is a sure thing, it isn’t always true”?
In general, I think you’re right about not being fanatical about definitions. But what was described, in the article and in the comment, is entirely the wrong use of the word “arbitrage.” Arbitrage is certainly not speculation (about as wrong a use of the word arbitrage as there is). Arbitrage is distinct from hedging, as well. Arbitrage is not a diversification tactic.
So I can’t help but conclude that your “a word can have many meanings” idea is just an applause light. Did I miss your alternative definition, of which mine is a subset, or was I just plain not squishy enough for your taste?
The problem is, what do you mean by the Wiktionary entry is clearly wrong? They seem pretty reasonable to this layman. Do you mean that they do not exclude every meaning including the possibility of loss? By what authority is this open-mindedness ‘wrong’? Did Jehovah in some obscure Numbers passage lay down this rule? Or is it just that you always use ‘arbitrage’ in the no-possible-loss sense, and so it’s incorrect for anyone else to use it any other way?
I hold to a descriptivist view of language; the use of a language is its meaning. If people use arbitrage in senses which allow loss, then arbitrage can mean techniques which allow loss. (Such techniques are a superset of techniques which don’t allow loss, so it’s fair to call the narrower no-loss definitions ‘strong’ definitions, along the lines of the Strong and Weak AI hypotheses, for example.) At that point, all I need to do is show that the other meanings are widespread. Wikipedia has it, and serves it up to ~1,600 viewers a day; Wiktionary probably adds a few hundred hits to that. The Google Books has hits that explicitly point out that they will henceforth use ‘arbitrage’ in its narrow sense; other books simply define it in a broad sense. The News hits demonstrate that the wider meanings are likewise in widespread use. (Your Google search has no relevance, any more than if I had instead said ‘bgrah449 is using the narrow definition of abitrage’, which ironically actually has a non-LW hit.)
I would disagree here. The article, perhaps, but the comment to which I was responding was clearly using the broader definitions: http://lesswrong.com/lw/1ia/arbitrage_of_prediction_markets/1b12
Long-Term Capital Management, from the popular history books I’ve read on them (and 1 or 2 academic articles long ago), did not believe it was an overall arbitrage. Arbitrages in the risk-free sense were taken when they found them, but much of their business was looking for mismatches which were not risk-free, but which they could exploit with leverage and hedge themselves against. They figured that they could only be killed by century-events or rarer. If they were just risk-free arbitraging, then they could never have been killed; if you can have losses on a risk-free arbitrage, an arbitrage in the narrow sense, then it’s not such an arbitrage, by definition.
Thus, bringing up the strategy of diversification, and LTCM in particular, only makes sense if mattnewport was thinking of arbitrage in the broader sense. (How can 100 risk-free arbitrages across the global economy be any safer than 100 risk-free arbitrages in just the USA? 100 0 = 100 0.) This was my original point: you and Blueberry both seemed (to me) to be discussing narrow/strong arbitrages, and mattnewport was putting forth a broad/weak arbitrage.
Ironically, ‘applause light’ can itself be an applause light.
For the record, I was indeed thinking of statistical arbitrage.
The Wiktionary entry is clearly wrong in that it isn’t a definition at all. The definition of “running” isn’t “what you do at a marathon.”
1,600 people a day doesn’t change the meaning of a word.
Statistical arbitrage is named thus because over an infinite time period, it is arbitrage.
Yes it does. Bgrah449, meet human language.
I don’t think so. I think “Statistical arbitrage” is marketing. As long as there is risk of ruin statistical arbitrage is still risky, even over infinite time. LTCM isn’t going to show a profit ever.
Pull out your OED on me. This is a subject I know. You are wrong.
For the benefit of the conversation, and posted without taking a position, here is the OED’s definition of arbitrage:
Here is the OED’s definition of Arbitration of Exchange:
ETA: One needs a subscription to follow those links.