Structuring the Prediction Markets
Chris F. Masse March 13th, 2007
[...] The drawback to this system is that in order for the market to work, there must be sufficient liquidity. If just a few people are trading, they simply may not come to agreement on a price and thus exchange contracts. Without liquidity, the market will just languish and be unsuccessful.
There are two particularly great benefits to a CDA market, however. One is that prices can make instantaneous jumps. If a presidential candidate makes a huge gaffe, a contract that represents their election chances can dive from 60 to 20 in one trade, something that is difficult to achieve with an algorithm. The second is that traders specify their opinions exactly, by placing bids or asks at specific prices. [...]
Jed Christiansen on MSR and DPMM:
[...] There are drawbacks to [MSR and DPMM], however, and they mirror the advantages of CDA’s. Firstly, it takes them more time and trading to respond to instantaneous price jumps. In thick markets, this largely doesn’t matter. But in thinner markets with less volume (such as many corporate markets), this could certainly become an issue. A second drawback is that to make the algorithm work it may take some financial subsidisation. In a play-money market this really shouldn’t matter, and specifically applies only to the MSR structure, which is currently a bit more common than the DPM structure. Finally, while algorithms deal nicely with contracts that range from 0-100, they can be difficult to use in other ranges because of how the prices are set to move with each share purchase.
The huge advantage to [MSR and DPMM] is that they offer infinite liquidity to traders. This can be a very important factor for new exchanges, particularly as new users want to get up and running immediately. Trading immediately, and seeing the effect of a price change, can be a very valuable tool in order to get prediction markets adopted in an organisation. [...]
Curious on how JC views the Sim Exchange.
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Somehow the phrase “infinite liquidity” came to be associated with the DPM, but this concept is orthogonal to auctions vs. algorithms and is only relevant to real vs. play money markets.
Algorithms are certainly more usable. Now, you could imagine a CDA market where the auction isn’t visible to new users and where liquidity is always provided by the house, but in that case either the liquidity will be provided according to an algorithm — or by discretion, in which case the information aggregation may be biased and broken.
Hi Jed Christiansen,
Good explainer. Thanks. I will add it in my list.
Explainers
http://www.chrisfmasse.com/3/3/explainers/
Implementing Hanson’s Market Maker
http://blog.oddhead.com/2006/1.....ket-maker/