In most domains except the most hardened part of the stock market counterparty risk is generally >5%.
This seems quite wrong to me:
High Yield Corporate Bond OAS spreads are <5% according to bloomberg, and most of that is economic risk, not “you will get screwed by a change of rules” risk.
Trades on US stock exchanges almost always succeed, many more 9s than just one.
If I buy a product in a box in a supermarket the contents of the box match the label >>95% of the time.
Banks make errors with depositor balances <<5% of the time.
Most employers manage to pay fortnightly wages on time without missing one or more paycheques per year.
Once you’re seated in an Uber or Taxi they take you to your destination almost all the time.
Your utility company fulfills its obligations to supply your house >>95% of the time under all but the most extreme circumstances.
Most employees turn up >95% of non-holiday days, and most students maintain >95% attendance.
Sorry, I wanted to say “except the most hardened parts of the world (like the stock market)”. I agree with you that basically anything in the stock market has much less counterparty risk than that. I disagree with basically all non-trading examples you give.
Once you’re seated in an Uber or Taxi they take you to your destination almost all the time.
My sense is around 1⁄20 Ubers don’t show up, or if they show up, fail to do their job in some pretty obvious and clear way.
If I buy a product in a box in a supermarket the contents of the box match the label >>95% of the time.
True for the most commoditized products. For anything else error rates seem to me to be around 5%. My guess is my overall Amazon error rate has been around 2%, which is lower, but not much lower (usually Amazon sent me something broken that previously was returned where they couldn’t spot the error).
Most employers manage to pay fortnightly wages on time without missing one or more paycheques per year.
I think that’s false, at least the statistics on wage theft seemed quite substantial to me. I am kind of confused how to interpret these, but various different studies on Wikipedia suggest wage theft on-average to be around 5%-15% (higher among lower-income workers).
Your utility company fulfills its obligations to supply your house >>95% of the time under all but the most extreme circumstances.
I agree this is true for gas and water (and mostly true for electricity, though PG&E is terrible and Berkeley really has a lot of outages).
Overall, I think 5% counterparty risk seems about right for most contracts I sign or business relationship I have. I agree that trading infrastructure is quite robust and in highly commoditized environments you get below that, but that’s not the majority of my economic transactions.
I agree with you that basically anything in the stock market has much less counterparty risk than that. I disagree with basically all non-trading examples you give.
It’s not just the stock market, it’s true for the bond market, the derivatives market, the commodities market… financial markets, a category which includes prediction markets, cannot function effectively with counterparty risk anything like 5%.
My sense is around 1⁄20 Ubers don’t show up, or if they show up, fail to do their job in some pretty obvious and clear way.
If the Uber doesn’t show up I’m not sure that’s counterparty risk: you haven’t paid anything, so it seems more like them declining the contract. The equivalent for a prediction market would be if you hit ‘buy’ and the button didn’t work, not for when you have paid the money and then don’t get the result taken from you. That’s much less bad than if the trade went through and then was settled incorrectly.
I think that’s false, at least the statistics on wage theft seemed quite substantial to me. I am kind of confused how to interpret these, but various different studies on Wikipedia suggest wage theft on-average to be around 5%-15% (higher among lower-income workers).
I think those studies have significant methodological flaws, though unfortunately I can’t remember the specific issues off the top off my head, so this may not be very convincing to you.
I agree this is true for gas and water (and mostly true for electricity, though PG&E is terrible and Berkeley really has a lot of outages).
According to the first google hit, PG&E said the average customer suffered 255.9 minutes of outage in 2013, which is a lot higher than I expected, but is still only 100*255.9/(60*24*365) = 0.05%
It’s not just the stock market, it’s true for the bond market, the derivatives market, the commodities market… financial markets, a category which includes prediction markets, cannot function effectively with counterparty risk anything like 5%.
Hmm, maybe I am just failing to model something here. Isn’t really the only thing that happens when you have 5% randomly-distributed counterparty risk that you end up with like 5% spreads? That seems fine to me.
To be clear, I don’t feel very confident here, I just don’t really understand why you can’t just price in counterparty risk and then maybe end up with some bigger spreads (which I do agree is sad for prediction markets, but for most markets I don’t mind the spread that much).
This seems quite wrong to me:
High Yield Corporate Bond OAS spreads are <5% according to bloomberg, and most of that is economic risk, not “you will get screwed by a change of rules” risk.
Trades on US stock exchanges almost always succeed, many more 9s than just one.
If I buy a product in a box in a supermarket the contents of the box match the label >>95% of the time.
Banks make errors with depositor balances <<5% of the time.
Most employers manage to pay fortnightly wages on time without missing one or more paycheques per year.
Once you’re seated in an Uber or Taxi they take you to your destination almost all the time.
Your utility company fulfills its obligations to supply your house >>95% of the time under all but the most extreme circumstances.
Most employees turn up >95% of non-holiday days, and most students maintain >95% attendance.
Sorry, I wanted to say “except the most hardened parts of the world (like the stock market)”. I agree with you that basically anything in the stock market has much less counterparty risk than that. I disagree with basically all non-trading examples you give.
My sense is around 1⁄20 Ubers don’t show up, or if they show up, fail to do their job in some pretty obvious and clear way.
True for the most commoditized products. For anything else error rates seem to me to be around 5%. My guess is my overall Amazon error rate has been around 2%, which is lower, but not much lower (usually Amazon sent me something broken that previously was returned where they couldn’t spot the error).
I think that’s false, at least the statistics on wage theft seemed quite substantial to me. I am kind of confused how to interpret these, but various different studies on Wikipedia suggest wage theft on-average to be around 5%-15% (higher among lower-income workers).
I agree this is true for gas and water (and mostly true for electricity, though PG&E is terrible and Berkeley really has a lot of outages).
Overall, I think 5% counterparty risk seems about right for most contracts I sign or business relationship I have. I agree that trading infrastructure is quite robust and in highly commoditized environments you get below that, but that’s not the majority of my economic transactions.
It’s not just the stock market, it’s true for the bond market, the derivatives market, the commodities market… financial markets, a category which includes prediction markets, cannot function effectively with counterparty risk anything like 5%.
If the Uber doesn’t show up I’m not sure that’s counterparty risk: you haven’t paid anything, so it seems more like them declining the contract. The equivalent for a prediction market would be if you hit ‘buy’ and the button didn’t work, not for when you have paid the money and then don’t get the result taken from you. That’s much less bad than if the trade went through and then was settled incorrectly.
I think those studies have significant methodological flaws, though unfortunately I can’t remember the specific issues off the top off my head, so this may not be very convincing to you.
According to the first google hit, PG&E said the average customer suffered 255.9 minutes of outage in 2013, which is a lot higher than I expected, but is still only 100*255.9/(60*24*365) = 0.05%
Hmm, maybe I am just failing to model something here. Isn’t really the only thing that happens when you have 5% randomly-distributed counterparty risk that you end up with like 5% spreads? That seems fine to me.
To be clear, I don’t feel very confident here, I just don’t really understand why you can’t just price in counterparty risk and then maybe end up with some bigger spreads (which I do agree is sad for prediction markets, but for most markets I don’t mind the spread that much).