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A Parimutuel Market Microstructure for Contingent Claims

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  • Jeffrey Lange
  • Nicholas Economides

Abstract

Parimutuel principles are widely used as an alternative to fixed odds gambling in which a bookmaker acts as a dealer by quoting fixed rates of return on specified wagers. A parimutuel game is conducted as a call auction in which odds are allowed to fluctuate during the betting period until the betting period is closed or the auction ‘called’. The prices or odds of wagers are set based upon the relative amounts wagered on each risky outcome. In financial microstructure terms, trading under parimutuel principles is characterised by (1) call auction, non‐continuous trading; (2) riskless funding of claim payouts using the amounts paid for all of the claims during the auction; (3) special equilibrium pricing conditions requiring the relative prices of contingent claims equal the relative aggregate amounts wagered on such claims; (4) endogenous determination of unique state prices; and (5) higher efficiency. Recently, a number of large investment banks have adopted a parimutuel mechanism for offering contingent claims on various economic indices, such as the US Nonfarm payroll report and Eurozone Harmonised inflation. Our paper shows how the market microstructure incorporating parimutuel principles for contingent claims which allows for notional transactions, limit orders, and bundling of claims across states is constructed. We prove the existence of a unique price equilibrium for such a market and suggest an algorithm for computing the equilibrium. We also suggest that for a broad class of contingent claims, that the parimutuel microstructure recently deployed offers many advantages over the dominant dealer and exchange continuous time mechanisms.

Suggested Citation

  • Jeffrey Lange & Nicholas Economides, 2005. "A Parimutuel Market Microstructure for Contingent Claims," European Financial Management, European Financial Management Association, vol. 11(1), pages 25-49, January.
  • Handle: RePEc:bla:eufman:v:11:y:2005:i:1:p:25-49
    DOI: 10.1111/j.1354-7798.2005.00274.x
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    References listed on IDEAS

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    1. Michael Powers & Martin Shubik & Shun Yao, 1998. "Insurance market games: Scale effects and public policy," Journal of Economics, Springer, vol. 67(2), pages 109-134, June.
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    Cited by:

    1. Shipra Agrawal & Erick Delage & Mark Peters & Zizhuo Wang & Yinyu Ye, 2009. "A Unified Framework for Dynamic Pari-Mutuel Information Market Design," Papers 0902.2429, arXiv.org.
    2. Razvan Tarnaud, 2019. "Convergence within binary market scoring rules," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 68(4), pages 1017-1050, November.
    3. Hee Su Roh & Yinyu Ye, 2015. "Market Making with Model Uncertainty," Papers 1509.07155, arXiv.org, revised Nov 2015.
    4. Shipra Agrawal & Erick Delage & Mark Peters & Zizhuo Wang & Yinyu Ye, 2011. "A Unified Framework for Dynamic Prediction Market Design," Operations Research, INFORMS, vol. 59(3), pages 550-568, June.
    5. Erhan Bayraktar & Alexander Munk, 2016. "High-Roller Impact: A Large Generalized Game Model of Parimutuel Wagering," Papers 1605.03653, arXiv.org, revised Mar 2017.

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