Interpreting the Predictions of Prediction Markets
AbstractParticipants in prediction markets such as the Iowa Electronic Markets trade all-or-nothing contracts that pay a dollar if and only if specified future events occur. Researchers engaged in empirical study of prediction markets have argued broadly that equilibrium prices of the contracts traded are market probabilities' that the specified events will occur. This paper shows that if traders are risk-neutral price takers with heterogenous beliefs, the price of a contract in a prediction market reveals nothing about the dispersion of traders' beliefs and partially identifies the central tendency of beliefs. Most persons have beliefs higher than price when price is above 0.5, and most have beliefs lower than price when price is below 0.5. The mean belief of traders lies in an interval whose midpoint is the equilibrium price. These findings persist even if traders use price data to revise their beliefs in plausible ways.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10359.
Date of creation: Mar 2004
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Other versions of this item:
- Manski, Charles F., 2006. "Interpreting the predictions of prediction markets," Economics Letters, Elsevier, vol. 91(3), pages 425-429, June.
- D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-03-07 (All new papers)
- NEP-CFN-2004-03-07 (Corporate Finance)
- NEP-FIN-2004-03-07 (Finance)
- NEP-MIC-2004-03-07 (Microeconomics)
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