Contract
Definition
A contract in a prediction market is a tradable asset representing a specific outcome of a future event. Each contract has a clear payoff structure that depends on whether the predicted outcome occurs.
How Contracts Work
Binary Contracts
- Most common type in prediction markets
- Two possible outcomes: Yes or No
- Standard payout: $1 (or 100¢) for winning contracts, $0 for losing contracts
- Price represents implied probability (e.g., $0.65 = 65% probability)
Example
Consider a market asking: "Will it rain in New York on June 15, 2024?"
- Yes contract priced at $0.35: If it rains, you get $1; if not, you get $0
- No contract priced at $0.65: If it doesn't rain, you get $1; if it does, you get $0
Multi-Outcome Contracts
- Used in categorical markets with more than two outcomes
- Example: "Who will win the 2024 Presidential Election?" might have contracts for each candidate
- Only one contract pays out $1, all others expire worthless
Contract Lifecycle
- Creation: Market is created with clear resolution criteria
- Trading: Participants buy and sell contracts, prices fluctuate
- Resolution: Event occurs, official outcome is determined
- Settlement: Winning contracts pay out, losing contracts expire
Key Characteristics
- Fungibility: All contracts of the same type are interchangeable
- Transferability: Can be traded freely until market resolution
- Limited Liability: Maximum loss is the purchase price
- Clear Payoff: Predetermined payout structure (usually $1 or $0)
Pricing
Contract prices fluctuate based on:
- Supply and demand
- New information about the event
- Time until resolution
- Overall market sentiment
The price of a contract can be interpreted as the market's collective belief about the probability of that outcome occurring.