Strategies in dynamic pari-mutual markets

Abstract

We present a strategic model for pari-mutual markets by traders using a cumulative utility function. Under this model, we derive guidelines for the traders on how much to buy or sell. Those guidelines can be implemented with three action combinations, called strategies. We prove that those strategies are payoff equivalent for both the involved trader and the others in the current transaction. However, in the long run, their payoffs can be quite different. We show that the buy-only strategy(BOS) achieves the highest market capitalization for the current transaction. In addition, simulation results also prove that BOS always yields the fastest growth of market capitalization even when multiple stages are taken into consideration. Simulation results also show that BOS is a better revelation of the traders' personal beliefs, though it exhibits a higher risk in traders' payoffs. © 2008 Springer Berlin Heidelberg.