How Is Pricing Determined?

Another key property of LMSR is that the price of each option pi is the marginal derivative of the cost function.

This means pi represents the marginal cost the user must pay to buy one more unit of that option.

This implies the following:

• As more users buy shares of a particular option, its price rises gradually.

• Over time, the price approaches the market’s collective subjective probability of that outcome.

• Regardless of liquidity conditions, the cost curve is always upward sloping. Buying more shares always results in increasing marginal costs.