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How Do Prediction Market Fees Affect Prices and Participants?

Author

Listed:
  • Karl Whelan

Abstract

The CFTC has recently licensed a commercial prediction market to operate in the US. Previous theoretical work has not incorporated that prediction markets charge fees. We examine the impact of fees by introducing them to a model in which the market price equals the true probability when there are no fees. We find that fees charged on winnings generally mean contract prices for low probability outcomes are below the true probability but the impact of fees means prediction markets feature a form of favorite-longshot bias: Post-fee loss rates depend negatively on the probability of the event being backed.

Suggested Citation

  • Karl Whelan, 2023. "How Do Prediction Market Fees Affect Prices and Participants?," Working Papers 202306, School of Economics, University College Dublin.
    • Handle: RePEc:ucn:wpaper:202306
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    File URL: http://hdl.handle.net/10197/24384
    File Function: First version, 2023
    Download Restriction: no
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    Keywords

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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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