Arbitrage Opportunities and Market-Making Traders in Prediction Markets

Prediction markets are a promising approach for predicting uncertain future events and developments. These markets will work well if they are efficient and in efficient markets, one does not expect arbitrage opportunities to be persistent. This paper therefore studies whether pure arbitrage opportunities existed in a sports prediction market. Moreover, market liquidity can become an issue in prediction markets since new information is potentially not immediately reflected in trading prices and traders might also lose interest in the markets if they are il liquid. This paper therefore analyzes whether traders try to exploit il liquidity by taking on the role of market makers in prediction markets. Our analysis of a sports prediction market for the FIFA World Cup 2006 shows that prediction markets also appear to be efficient in the sense that there are few substantial arbitrage opportunities available. Furthermore, we find that market markers play an important role in prediction markets. They serve as liquidity providers and allow for continuous trading.