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For a college project I'm tasked with implementing prediction market. Which model of it I'd better choose?

I want something useful and simple enough for other people to quickly understand and use. (This project is to be used in campus internally).

For now on I'm considering binary option model, but as I understand buying in such model would require me to solve some kind of combinational optimization problem: if I want to buy up to x$ of contracts and there are available contracts with returns r_1, r_2, ... and prices p_1, p_2, ... which looks like a classical knapsack problem to me.

Would it be better to go with some model which uses market-maker?

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check out: www.huunu.com/market - this is the one That Robin Hanson is on the Board of. –  user4639 Jan 21 '13 at 21:27
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There are two excellent choices for implementing prediction markets: (1) Use book orders that stand until filled, just as intrade.com does. (2) Use an automated market maker (like Robin Hanson's) that stands ready to make trades.

The book orders model is very simple to implement, but can suffer from very wide Bid/Ask spreads. And, it can be tough to bet people to book orders that may never get filled.

Hanson's market maker, on the other hand, supports instant trades for anybody. The downside of automated market makers are two-fold: they often require a fair bit of sophisticated math, and they can lose (a bounded amount of) money. See http://blog.oddhead.com/2006/10/30/implementing-hansons-market-maker/

You can use book orders and a market-maker together, but it complicates some things. Hanson's market maker moves the prices continuously which makes things a little funny when you hit the price of a standing book order.

Pennock also has one or two market makers, but Hanson's is the only one that I'm well-versed in. I don't know if Pennock's market makers have fixed loss like Hanson's.

Short selling relies on the notion of borrowing shares, which is outside the scope of most prediction markets. When you have a market maker, you can always purchase the securities that represent the opposite outcome to the one you wanted to short, so there's really no need to short sell---another advantage to having a market maker.

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The proposed market maker is very interesting. Can I use book orders and market-maker together? So it sometimes turns on to inject liquidity into market? Are there other market-makers fix fixed loss? How do they compare to it? –  user3587 Jan 12 '13 at 11:46
    
Also how do I implement short selling in book order model? –  user3587 Jan 12 '13 at 11:47
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