Belief Aggregation with Automated Market Makers

Abstract

We consider the properties of a cost function based automated market maker aggregating the beliefs of risk-averse traders with finite budgets. Individuals can interact with the market maker an arbitrary number of times before the state of the world is revealed. We show that the resulting sequence of prices offered by the market maker is convergent under general conditions, and explore the properties of the limiting price and trader portfolios. The limiting price cannot be expressed as a function of trader beliefs, since it is sensitive to the market maker's cost function as well as the order in which traders interact with the market. For a range of trader preferences, however, we show numerically that the limiting price provides a good approximation to a weighted average of beliefs, inclusive of the market designer's prior belief as reflected in the initial contract price. This average is computed by weighting trader beliefs by their respective budgets, and weighting the initial contract price by the market maker's worst-case loss, implicit in the cost function. Since cost function parameters are chosen by the market designer, this allows for an inference regarding the budget-weighted average of trader beliefs.

Keywords: Prediction Markets, Market Scoring Rules, Automated Market Makers

JEL Classification: D84, G13