Quantitative Finance, 2023
Commercial prediction markets charge fees. This paper shows that once you account for those fees, prices can still be informative while expected returns to traders are systematically negative, with the worst deals often on low-probability “longshot” contracts. Different fee structures – for example a flat fee per contract versus a fee on winnings – can have different impacts on prices and average returns.
Key research finding: Fees can generate a favourite–longshot type pattern in returns even when the traders in the market are, on average, correct.
Practical advice: If a prediction market charges fees, don’t treat the contract price as the whole story. Fees can turn fair-looking prices into bad bets, especially on longshots.