PredictIt is a website offering a prediction market. It allows users to trade shares which pay off $1 if a particular event occurs. As of January 1st, 2019, a market existed in which participants could trade shares of particular candidates for the Democratic presidential nomination. Shares in each candidate could be bought for a listed price, and would pay off a dollar to the purchaser in the event that a particular candidate was successfully nominated at the Democratic National Convention in July 2020. The actual prices in dollars for these candidates on January 1st, 2019 are listed below, as are the payoffs in dollars in the event of a particular candidate winning.

Imagine that today is January 1st, 2019. Assume that you can buy or sell a risk free asset today that pays off $1 in July, 2020 no matter which candidate wins for 95 cents. Further assume that one of O'Rourke, Harris, Biden, Sanders, or Warren will certainly be the nominee. You can buy or sell shares in any combination of candidates. If you sell a share in a candidate and that candidate wins, you are required to pay a dollar to the purchaser of the share.

a. Construct an arbitrage strategy from the payoffs above and the risk free asset. What assets would you have bought and what assets would you have sold to take advantage of this strategy?

b. Show the payoffs for this strategy on July 2020 had each candidate won.

c. Note once again that this is a hypothetical example and the arbitrage is may not hold in practice. What are the assumptions in the made in the problem that may deviate from the real world?

Payoffs O'Rourke Harris Biden Sanders Warren Asset Price wins wins wins wins wins O'Rourke 0.19 O Harris 0.18 Biden 0.18 Sanders 0.14 Warren 0.10 OO OO O - O O O O