Optimizing the liquidity parameter of logarithmic market scoring rules prediction markets

Suparerk Lekwijit, Daricha Sutivong

Research output: Contribution to journalArticlepeer-review

1 Scopus citations

Abstract

Purpose: Prediction markets are techniques to aggregate dispersed public opinions via market mechanisms to predict uncertain future events’ outcome. Many experiments have shown that prediction markets outperform other traditional forecasting methods in terms of accuracy. Logarithmic market scoring rules (LMSR) is one of the most simple and widely used market mechanisms; however, market makers have to confront crucial design decisions including the setting of the parameter “b” or the “liquidity parameter” in the price functions. As the liquidity parameter has significant effects on the market performance, this paper aims to provide a comprehensive basis for the setting of the parameter. Design/methodology/approach: The analyses include the effects of the liquidity parameter on the forecast standard error and the amount of time for the market price to converge to the true value. These experiments use artificial prediction markets, the proposed simulation models that mimic real prediction markets. Findings: The simulation results indicate that prediction market’s forecast standard error decreases as the value of the liquidity parameter increases. Moreover, for any given number of traders in the market, there exists an optimal liquidity parameter value that yields appropriate price adaptability and leads to the fastest price convergence. Originality/value: Understanding these tradeoffs, the market makers can effectively determine the liquidity parameter value under various objectives on the standard error, the time to convergence and cost.

Original languageEnglish (US)
Pages (from-to)736-754
Number of pages19
JournalJournal of Modelling in Management
Volume13
Issue number3
DOIs
StatePublished - Oct 15 2018
Externally publishedYes

Keywords

  • Aggregation of beliefs
  • Information markets
  • Logarithmic market scoring rules
  • Market design
  • Prediction markets
  • Trading mechanism

ASJC Scopus subject areas

  • Decision Sciences(all)
  • Strategy and Management
  • Management Science and Operations Research

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