Freitag, 27. Januar 2012

Market Makers & Prediction Markets

A while ago I posted on the idea of futarchy and followed up with a post on implementation and issues of virtual stock markets.

I only posted links on auction markets, i.e. where one party makes an offer, another one a request and the system finds a match. That only works good for systems with high liquidity. Especially on prediction markets with combinatorical outcomes (e.g. of the form "if person A becomes the candidate for party 1, then party 2 will win the election" or even more complex constructions) this is difficult: you need to find people making similar opposite bets to match. A way around of this is to use a market maker instead of an auctioneer. It takes the trades directly instead of leading a negotiation between to parties. The price is set automatically by the system. This, of course, also has drawbacks. In a real life system, the market maker provides liquidity and thus is at risk losing some money. Moreover, the pricing of the goods depends on parameters of the market maker. Wrong values for thick or thin (i.e. markets with many/few participants) might make the price either bounce up and down or move only tiny bits.

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