Key Design Elements of Prediction Markets

Before studying more advanced applications of prediction markets, it is necessary to gain a basic understanding of their key design elements. Like any market, prediction markets have to be designed and implemented very carefully in order to ensure that they are suitable for aggregating traders’ information (Weinhardt et al., 2003, Weinhardt et al., 2006a). The key design elements comprise the specification of

contracts

traded in a prediction market, the

trading mechanism

, and the

incentives

provided to ensure information revelation (Spann and Skiera, 2003). Moreover, diversity of information is required in order to provide a basis for trading (Wolfers and Zitzewitz, 2004). Heterogeneous expectations about the future among traders are desirable and the selection of

traders

is thus also considered a key design issue (Tziralis and Tatsiopoulos, 2007b). The following subsections describe these design elements in more detail.