How Market Makers Can Price Quotes Around a Lagging TWAP on Polymarket

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On prediction markets like Polymarket, market makers face a unique challenge when quoting around a Time-Weighted Average Price (TWAP), which can lag behind faster-moving underlying references during volatile periods. A naive approach of centering bids and asks on the current TWAP risks stale quotes that informed traders can exploit. A more robust model adjusts the quoting midpoint by estimating where the TWAP is heading, using the divergence between the TWAP and a faster external reference such as a Chainlink price feed. Beyond shifting the midpoint, the bid-ask spread itself should widen dynamically in response to TWAP momentum, short-term volatility, and time-to-resolution risk. Inventory exposure is also factored in to skew quotes and reduce adverse selection during rapid price moves.

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