Arbitrage Opportunities and Market-Making Traders in Prediction Markets

Prediction markets are a promising approach forpredicting uncertain future events and developments.These markets will work well if they are efficient and inefficient markets, one does not expect arbitrageopportunities to be persistent. This paper thereforestudies whether pure arbitrage opportunities existed ina sports prediction market. Moreover, market liquiditycan become an issue in prediction markets since newinformation is potentially not immediately reflected intrading prices and traders might also lose interest inthe markets if they are illiquid. This paper thereforeanalyzes whether traders try to exploit illiquidity bytaking on the role of market makers in predictionmarkets.Our analysis of a sports prediction market for theFIFA World Cup 2006 shows that prediction marketsalso appear to be efficient in the sense that there arefew substantial arbitrage opportunities available.Furthermore, we find that market markers play animportant role in prediction markets. They serve asliquidity providers and allow for continuous trading.