Pari-mutuel markets: Mechanisms and performance

Abstract

Recently, there has been an increase in the usage of centrally managed markets which are run by some form of pari-mutuel mechanism. A pari-mutuel mechanism is characterized by the ability to shield the market organizer from financial risk by paying the winners from the stakes of the losers. The recent introduction of new, modified pari-mutuel methods has spurred the growth of prediction markets as well as new financial derivative markets. Coinciding with this increased usage, there has been much work on the research front which has produced several mechanisms and a slew of interesting results. We will introduce a new pari-mutuel market-maker mechanism with many positive qualities including convexity, truthfulness and strong performance. Additionally, we will provide the first quantitative performance comparison of some of the existing pari-mutuel market-maker mechanisms. © Springer-Verlag Berlin Heidelberg 2007.