Reading a prediction-market price

Question

A prediction-market contract pays \1 if an event happens and \0 otherwise. It is quoted 62 bid / 65 ask, in cents. What probability does the market imply, and what edge does the market maker earn on a round trip?

Accepted Answer

For a binary contract that pays \1, the price in dollars is the implied probability. If you buy at the ask of \0.65, you break even when the true probability is 0.65: you pay 65 cents to receive \1 	imes p on average, so fair value is p = 0.65. The bid of \0.62 implies 0.62 the same way. The market's single best estimate is the midpoint: p \approx \frac{0.62 + 0.65}{2} = 0.635 = 63.5\%. The bid and ask straddle that fair value. The market maker's edge is the spread: buy from a seller at 0.62 and sell to a buyer at 0.65, capturing 0.65 - 0.62 = \0.03 per contract on the round trip, or half th…

Reading a prediction-market price

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