When Certainty Is Not Worth It: Capital Lock-Up and Settlement Discounting in Prediction Markets

2026-05-29

AI Summary

This study investigates how settlement delays in collateralized prediction markets induce capital lock-up that distorts price formation, particularly manifesting as persistent term-structure biases even when outcomes are nearly certain. By constructing on-chain annualized settlement yield (ASW) curves, the paper identifies and quantifies—for the first time—the term structure of settlement discounts in prediction markets. Empirical analysis reveals that after adjusting for settlement frictions, the term gradient of near-certain contracts declines by 48–88%. The negRisk mechanism effectively compresses these discounts, while interest-bearing collateral substantially flattens the term structure. The findings demonstrate that pricing quality is endogenous to settlement design and capital efficiency, establishing settlement frictions as a primary source of price distortion.

Abstract

Collateralized prediction markets are contingent-claim markets in which economic uncertainty can disappear before winning claims become redeemable. This paper studies the pricing effect of that delay. When collateral remains locked until oracle settlement, a near-certain dollar is a delayed dollar, so prices embed a maturity-dependent settlement discount in addition to beliefs about outcomes. We recover an implied settlement-discount term structure from persistent near-certain contracts using realized settlement times and summarize it as an annualized settlement wedge (ASW). The recovered wedges are positive, maturity-dependent, and time-varying. Adjusting pricesby these curves reduces the near-certainty horizon gradient by roughly 48-88%, indicating that much of the raw maturity pattern reflects priced settlement frictions rather than forecast error alone. Market architecture changes the wedge: negRisk conversion compresses discounts by recycling part of the position into synthetic collateral, while yield-bearing collateral flattens the term structure by reducing the opportunity cost of lock-up. The results show that pricing quality in prediction markets is endogenous to settlement mechanics, collateral productivity, and capital-recycling design. Prediction-market prices therefore aggregate information through a financial infrastructure whose funding conditions are measurable and economically important.

Problem

• prediction markets
• settlement discounting
• collateral lock-up
• pricing bias
• settlement delay

Innovation

• settlement discounting
• collateral lock-up
• prediction markets
• annualized settlement wedge
• capital recycling