By far the biggest problem with interpreting (certain) prediction markets as probabilities, especially in the tails, is the fee structures. PredictIt charges 10% of all winnings plus a 5% withdrawal fee. The latter fee in particular strongly disincentivizes adding new money to arbitrage small deviations in the tails. E.g. if a “yes” contract is trading at 98 cents and you are 100% sure it will happen (and you’re correct), investing 98 cents now and withdrawing the resulting $1 after the market turns over (even if it ends tomorrow, so we abstract from inflation), will yield a loss of 0.98-((1-.98)*0.9+0.98)*0.95 = 3.19 cents. This problem is much smaller when betting on long shot outcomes, so it will tend to push prediction markets away from “certainty” on outcomes. You can make a copy of this calculator for PredictIt to see the effects.
This problem is somewhat ameliorated by people making multiple sequential bets (this amortizes the 5% withdrawal fee over more bets—in the limit, I think that if you made an infinite number of (on average winning) bets, the 5% withdrawal fee would become just a fee on profits), but I think it’s a significant issue in the tails.
Correct, and it is just one further issue with any prediction market mechanism deployed on a real money (or a fiat currency impostering as a real money, for the avoidance of doubt).
By far the biggest problem with interpreting (certain) prediction markets as probabilities, especially in the tails, is the fee structures. PredictIt charges 10% of all winnings plus a 5% withdrawal fee. The latter fee in particular strongly disincentivizes adding new money to arbitrage small deviations in the tails. E.g. if a “yes” contract is trading at 98 cents and you are 100% sure it will happen (and you’re correct), investing 98 cents now and withdrawing the resulting $1 after the market turns over (even if it ends tomorrow, so we abstract from inflation), will yield a loss of 0.98-((1-.98)*0.9+0.98)*0.95 = 3.19 cents. This problem is much smaller when betting on long shot outcomes, so it will tend to push prediction markets away from “certainty” on outcomes. You can make a copy of this calculator for PredictIt to see the effects.
This problem is somewhat ameliorated by people making multiple sequential bets (this amortizes the 5% withdrawal fee over more bets—in the limit, I think that if you made an infinite number of (on average winning) bets, the 5% withdrawal fee would become just a fee on profits), but I think it’s a significant issue in the tails.
Correct, and it is just one further issue with any prediction market mechanism deployed on a real money (or a fiat currency impostering as a real money, for the avoidance of doubt).