Comparing Prediction Market Structures, With an Application to Market Making

Ensuring sufficient liquidity is one of the key challenges for designers of prediction markets. Various market making algorithms have been proposed in the literature and deployed in practice, but there has been little effort to evaluate their benefits and disadvantages in a systematic manner. We introduce a novel experimental design for comparing market structures in live trading that ensures fair comparison between two different microstructures with the same trading population. Participants trade on outcomes related to a two-dimensional random walk that they observe on their computer screens. They can simultaneously trade in two markets, corresponding to the independent horizontal and vertical random walks. We use this experimental design to compare the popular inventory-based logarithmic market scoring rule (LMSR) market maker and a new information based Bayesian market maker (BMM). Our experiments reveal that BMM can offer significant benefits in terms of price stability and expect...

• Type: Journal
• Year: 2010
• Where: CORR
• Authors: Aseem Brahma, Sanmay Das, Malik Magdon-Ismail
• Keywords: CORR 2010, Education, Market, Market Makers, Random Walks