A Simple Automated Market Maker for Prediction Markets

2013 ◽  
pp. 541-559
Author(s):  
David Johnstone
Keyword(s):  
Behavioral Finance ◽  
Prediction Markets ◽  
Market Maker ◽  
Price Setting ◽  
Simulation Games ◽  
Prior Beliefs ◽  
Over The Counter ◽  
Market Makers ◽  
Market Simulation ◽  
Betting Markets

There is wide scope for reliance on automated “robot” market makers in prediction markets and market simulation games in experimental economics and behavioral finance. The market maker presented here is an alternative to the well-known but less easily understood Hanson market maker. It has the advantage of being easy to derive and makes a good mathematical introduction to the logic of automated bid and ask price–setting in prediction markets. Its main advantage is that the opening security price can be set arbitrarily between zero and one, so as to match the market maker’s prior beliefs. A weakness of the Hanson market maker is that it opens automatically with a uniform prior distribution. In many real-world applications, this is unrealistic and prone to cause the market maker unnecessary trading losses (on average). Common practice, such as in betting markets and over-the-counter financial markets for binaries, is to set opening prices based on expert subjective probabilities.

THE HIDDEN BEAUTY OF THE QUADRATIC MARKET SCORING RULE: A UNIFORM LIQUIDITY MARKET MAKER, WITH VARIATIONS

2012 ◽  
Vol 1 (2) ◽  
pp. 111-125 ◽  
Author(s):  
Michael Abramovicz
Keyword(s):  
Scoring Rules ◽  
Prediction Markets ◽  
Market Maker ◽  
Scoring Rule ◽  
Market Makers ◽  
Market Participants ◽  
Aggregate Information ◽  
Spectrum Market

For some applications, prediction markets that rely entirely on voluntary transactions between individual participants may provide insufficient liquidity to aggregate information effectively, especially where the number of participants is small. A solution to this problem is to rely on an automated market maker, which allows participants to buy from or sell to the house. Robin Hanson has described a class of automated market makers called market scoring rules. This Article examines a member of this class that has received little attention, the quadratic market scoring rule. Its prime virtue is that it provides uniform liquidity across the probability or prediction spectrum. Market participants will thus have the same incentive to do research that is expected to produce an expected change in the market prediction, regardless of the current prediction. Formulas are provided for implementing the quadratic market scoring rule, as well as variations, for example to implement conditional markets.

Optimizing the liquidity parameter of logarithmic market scoring rules prediction markets

2018 ◽  
Vol 13 (3) ◽  
pp. 736-754
Author(s):  
Suparerk Lekwijit ◽  
Daricha Sutivong
Keyword(s):  
Standard Error ◽  
Market Price ◽  
Simulation Models ◽  
Scoring Rules ◽  
Prediction Markets ◽  
Market Mechanisms ◽  
Content Type ◽  
Market Makers ◽  
True Value ◽  
Price Functions

Purpose Prediction markets are techniques to aggregate dispersed public opinions via market mechanisms to predict uncertain future events’ outcome. Many experiments have shown that prediction markets outperform other traditional forecasting methods in terms of accuracy. Logarithmic market scoring rules (LMSR) is one of the most simple and widely used market mechanisms; however, market makers have to confront crucial design decisions including the setting of the parameter “b” or the “liquidity parameter” in the price functions. As the liquidity parameter has significant effects on the market performance, this paper aims to provide a comprehensive basis for the setting of the parameter. Design/methodology/approach The analyses include the effects of the liquidity parameter on the forecast standard error and the amount of time for the market price to converge to the true value. These experiments use artificial prediction markets, the proposed simulation models that mimic real prediction markets. Findings The simulation results indicate that prediction market’s forecast standard error decreases as the value of the liquidity parameter increases. Moreover, for any given number of traders in the market, there exists an optimal liquidity parameter value that yields appropriate price adaptability and leads to the fastest price convergence. Originality/value Understanding these tradeoffs, the market makers can effectively determine the liquidity parameter value under various objectives on the standard error, the time to convergence and cost.

Liquidity Provision and Cross Arbitrage in Continuous Double-Auction Prediction Markets

2014 ◽  
Vol 7 (3) ◽  
pp. 61-86
Author(s):  
Werner Antweiler
Keyword(s):  
Stock Market ◽  
Empirical Analysis ◽  
Double Auction ◽  
Prediction Markets ◽  
Market Maker ◽  
Micro Structure ◽  
Liquidity Provision ◽  
Novel Method ◽  
Continuous Double Auction ◽  
Bid Ask Spreads

Continuous double-auction prediction markets often exhibit low transaction volume due to substantial bid-ask spreads. This paper explores a novel method of providing artificial liquidity in continuous double-auction prediction markets by introducing an automated market maker that engages in zero-profit cross-arbitrage in multi-contract markets. Empirical analysis of observed bid-ask spreads, liquidity, offer acceptance, and order sizes in the 2008 UBC Election Stock Market provides additional new insights into the micro-structure of prediction markets. 

ON MARKET MAKER FUNCTIONS

2012 ◽  
Vol 3 (1) ◽  
pp. 61-63 ◽  
Author(s):  
Robin Hanson
Keyword(s):  
Scoring Rules ◽  
Double Auction ◽  
Market Maker ◽  
Main Function ◽  
Market Makers ◽  
Continuous Double Auction

Since market scoring rules have become popular as a form of market maker, it seems worth reviewing just what such mechanisms are intended to do.The main function performed by most market makers is to serve as an intermediary between people who prefer to trade at different times.  Traders who have the same favorite times to trade can show up together to an ordinary continuous double auction, and then make and accept offers to trade.  But when traders have different favorite times, a market maker can help them by first making offers that some of them will accept, and then later making opposite offers which others will accept.  By adjusting prices in his favor, a market maker can even profit from providing this service.

scholarly journals Welfare Effects of Market Making in Continuous Double Auctions

2017 ◽  
Vol 59 ◽  
pp. 613-650 ◽  
Author(s):  
Elaine Wah ◽  
Mason Wright ◽  
Michael P. Wellman
Keyword(s):  
Allocative Efficiency ◽  
Market Model ◽  
Model Parameters ◽  
Market Maker ◽  
Market Making ◽  
Market Makers ◽  
Continuous Double Auctions ◽  
Thin Markets ◽  
Heuristic Strategies ◽  
Fundamental Value

We investigate the effects of market making on market performance, focusing on allocative efficiency as well as gains from trade accrued by background traders. We employ empirical simulation-based methods to evaluate heuristic strategies for market makers as well as background investors in a variety of complex trading environments. Our market model incorporates private and common valuation elements, with dynamic fundamental value and asymmetric information. In this context, we compare the surplus achieved by background traders in strategic equilibrium, with and without a market maker. Our findings indicate that the presence of the market maker strongly tends to increase total welfare across various environments. Market-maker profit may or may not exceed the welfare gain, thus the effect on background-investor surplus is ambiguous. We find that market making tends to benefit investors in relatively thin markets, and situations where background traders are impatient, due to limited trading opportunities. The presence of additional market makers increases these benefits, as competition drives the market makers to provide liquidity at lower price spreads. A thorough sensitivity analysis indicates that these results are robust to reasonable changes in model parameters.

scholarly journals Market makers’ optimal price-setting policy for exchange-traded certificates

2016 ◽  
Vol 71 ◽  
pp. 206-226 ◽  
Author(s):  
Stefanie Baller ◽  
Oliver Entrop ◽  
Michael McKenzie ◽  
Marco Wilkens
Keyword(s):  
Price Setting ◽  
Optimal Price ◽  
Market Makers

INVENTORY HEDGING AND OPTION MARKET MAKING

2004 ◽  
Vol 07 (07) ◽  
pp. 853-878 ◽  
Author(s):  
ANTOINE GIANNETTI ◽  
RUI ZHONG ◽  
LIXIN WU
Keyword(s):  
Price Level ◽  
Supply And Demand ◽  
Market Maker ◽  
Price Setting ◽  
Market Making ◽  
Exercise Price ◽  
Reduce Risk ◽  
Theoretical Condition ◽  
Familiar Result ◽  
Option Market

In this paper, we develop an inventory-based approach to analyze the option market making activity. Indeed, we formulate and analytically solve the price-setting problem of a monopolistic option market maker facing exogenous public supply and demand first on a single exercise price (the "single option economy") and next on multiple exercise prices (the "multi-options economy"). While in the "single option economy" the familiar result that market maker inventory and price level are inversely related holds, the same is not necessarily true in the "multi-options economy". Additionally, we examine under which theoretical condition hedging is totally effective (i.e., the variance of the market maker hedged position is zero). Last but not least, our model is fully consistent with actual option market making practices, which consist in trading hedge portfolios to reduce risk. As such, our approach can be considered as a bridge between market microstructure and standard option pricing literature.

Market perceptions of liquid sovereign Sukūk: a new asset class?

2016 ◽  
Vol 9 (1) ◽  
pp. 87-108 ◽  
Author(s):  
Volker Nienhaus ◽  
Abdullah Karatas
Keyword(s):  
Time Series Data ◽  
Supply And Demand ◽  
Data Availability ◽  
Series Data ◽  
Over The Counter ◽  
Yield Curves ◽  
Content Type ◽  
Market Makers ◽  
Asset Class ◽  
Market Perception

Purpose This paper aims to explore whether the market perceives liquid international sovereign sukūk as distinct from comparable bonds and as an asset class of their own that could shield investors against turbulences in the bond markets. Design/methodology/approach If sukūk and bonds belong to the same asset class, then basically the same supply and demand factors determine inverstors’ activities in both markets. This should lead to matching patterns of yield curves for sukūk and bonds comparable in terms of issuers, maturity, currency, size, liquidity and rating. Only a rough analysis of holding and trading patterns of conventional and Islamic sukūk investors was possible, as most sukūk market transactions are “over-the-counter” and not registered in the Bloomberg database. However, price information could be used for an analysis of yield curves of liquid sovereign sukūk and comparable bonds. Findings Conventional investors participate in the sukūk market, but their influence on prices is rather small, as they act primarily as intermediaries (i.e. market makers) as opposed to price setters. The yield curves of the selected bonds and sukūk widely match. This suggests that bonds and liquid sovereign sukūk belong to the same asset class. Furthermore, as turbulences in conventional markets are also reflected in the sukūk markets, Islamic investors themselves play a role in the transmission. Research limitations/implications The study of holding patterns and of the market perception of sovereign sukūk and bonds required a focus on four countries with deep and (potentially) liquid sukūk markets (Malaysia, Turkey, Indonesia and Hong Kong) and US$-denominated international securities. Some suitable combinations of sukūk and bonds are relatively young issuances with time series data for two to three years only. Data on holding patterns are sketchy and require interpretations based on market knowledge. Practical implications Parallel yield curves indicate that conventional investors do not perceive international sovereign sukūk as an asset class of their own distinct from conventional government bonds. This market perception of liquid international sovereign sukūk could have an impact on other types of sukūk (e.g. on international corporate sukūk) if sovereign sukūk are taken as pricing and performance benchmarks. Originality/value The paper sheds light on institutional investor behavior in the bond and sukūk markets and outlines data availability issues that constrain quantitative analyses in over-the-counter markets.

DO POLLS OR MARKETS FORECAST BETTER? EVIDENCE FROM THE 2010 US SENATE ELECTIONS

2012 ◽  
Vol 5 (3) ◽  
pp. 64-74
Author(s):  
Leighton Vaughan Williams ◽  
Blake Saville ◽  
Herman Stekler
Keyword(s):  
Prediction Markets ◽  
Election Campaigns ◽  
Prediction Market ◽  
Senate Elections ◽  
Significant Difference ◽  
Betting Markets ◽  
Senate Election ◽  
Us Senate ◽  
Opinion Polls

In this paper, we seek to examine how well prediction markets performed, compared to opinion polls, in forecasting the outcome of the 2010 US Senate elections. Prediction markets are speculative or betting markets created or employed for the purpose of aggregating information and making predictions. To do this, we used data from the 2010 US Senate election campaigns, comparing the performance of an established prediction market with opinion polls. Overall we found no significant difference in the forecasting ability of the polls and prediction markets in the Senate races under examination.

DO GAMBLERS CORRECTLY PRICE MOMENTUM IN NBA BETTING MARKETS?

2012 ◽  
Vol 5 (1) ◽  
pp. 31-50 ◽  
Author(s):  
Jeremy Arkes
Keyword(s):  
Strong Evidence ◽  
Prediction Markets ◽  
Momentum Effect ◽  
Market Inefficiencies ◽  
Price Momentum ◽  
New Information ◽  
Betting Markets ◽  
Profit Opportunity

There is little research on whether new information is correctly synthesized in prediction markets.  Previous studies have found evidence consistent with, but have not proved, gambler misperceptions on the existence of momentum effects in the NBA.  I use novel momentum measures that, unlike prior studies, incorporate the strengths of the opponent and the wins (or losses).  With these measures, I test whether gamblers correctly synthesize information on momentum in the NBA.  Contrary to previous studies, I find strong evidence for the existence of a momentum effect.  Furthermore, gamblers incorporate momentum into their beliefs on the game outcomes.  Gamblers, however, significantly overstate the importance of momentum. But, there is little evidence that the extent of this gambler misperception is large enough to generate market inefficiencies, or profit opportunity.  Still, the gambler mis-pricing of the information has implications for how well new information is synthesized in other types of prediction markets.

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