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A Parimutuel Market Microstructure
for Contingent Claims Trading
By Jeffrey Lange* and Nicholas Economides**
November 21, 2001
Abstract
A parimutuel market microstructure for contingent claims trading is proposed and
analyzed. A parimutuel microstructure is a call auction where relative equilibrium prices
of contingent claims are endogenously determined using a specific mechanism. We
propose a market microstructure incorporating parimutuel principles which provides for
notional derivatives transactions, limit orders, and bundling of contingent claims across
states. This microstructure will be used by Longitude Inc.’s clients to transact derivatives
on economic statistics, weather, insurance losses and other types of risks. JPMorgan
Chase and Deutsche Bank are some of the financial institutions that will be holding
parimutuel auctions in early 2002.
* Longitude Inc., (212) 468-8509, (212) 468-8509(fax), email: jlange@ .
www: /.
** Stern School of Business, New York University, (212) 998-0864, fax (212) 995-4218,
email: neconomi@, www: /networks/.
Acknowledgements: We would like to thank Ken Baron of Longitude, Darrell Duffie of
Stanford University, and Michael Overton of the Courant Institute at NYU for providing
critical insight and support.
1
Contents
I. Introduction 3
II. Parimutuel Microstructure and Market Games 5
III. Parimutuel Microstructure for Contingent Claims Trading 13
A. Development of the Parimutuel Microstructure: Definitions 14
B. Parimutuel Equilibrium Pricing Conditions 17
C. Parimutuel Limit Order Book Equilibrium 20
1. Limit Order Book Equilibrium 21
2. An Example of Limit
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