Aggregation of Information and Beliefs in Prediction Markets
AbstractWe analyze a binary prediction market in which traders have heterogeneous prior beliefs and private information. Realistically, we assume that traders are allowed to invest a limited amount of money (or have decreasing absolute risk aversion). We show that the rational expectations equilibrium price underreacts to information. When favorable information to an event is available and is revealed by the market, the price increases and this forces optimists to reduce the number of assets they can (or want to) buy. For the market to equilibrate, the price must increase less than a posterior belief of an outside observer.
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Bibliographic InfoPaper provided by University of Copenhagen. Department of Economics. Finance Research Unit in its series FRU Working Papers with number 2007/01.
Length: 26 pages
Date of creation: May 2007
Date of revision:
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prediction markets; private information; heterogeneous prior beliefs; limited budget; underreaction;
Find related papers by JEL classification:
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
- D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
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- Amos Storkey, 2011. "Machine Learning Markets," Papers 1106.4509, arXiv.org.
- Stephanie Wang, 2012. "Speculative Overpricing in Asset Markets with Information Flows," Working Papers 489, University of Pittsburgh, Department of Economics, revised Jan 2012.
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