Discussion paper
DP17972 How Do Prediction Market Fees Affect Prices and Participants?
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. Fees charged on winnings mean this property no longer generally holds but trading fees that charge equal amounts on both sides of contracts preserve this feature. Prediction markets with fees feature a form of favorite-longshot bias: Post-fee loss rates depend negatively on the probability of the event being backed.
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