While most empirical analysis of prediction markets treats prices of binary options as predictions of the probability of future events, Manski (2004) has recently argued that there is little existing theory supporting this practice. We provide relevant analytic foundations, describing sufficient conditions under which prediction markets prices correspond with mean beliefs. Beyond these specific sufficient conditions, we show that for a broad class of models prediction market prices are usually close to the mean beliefs of traders. The key parameters driving trading behavior in prediction markets are the degree of risk aversion and the distribution of beliefs, and we provide some novel data on the distribution of beliefs in a couple of interesting contexts. We find that prediction markets prices typically provide useful (albeit sometimes biased) estimates of average beliefs about the probability an event occurs.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
12200.
Length: Date of creation: May 2006 Date of revision: Handle: RePEc:nbr:nberwo:12200
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Justin Wolfers & Eric Zitzewitz, 2004.
"Prediction Markets,"
NBER Working Papers
10504, National Bureau of Economic Research, Inc.
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Wolfers, Justin & Zitzewitz, Eric, 2004.
"Prediction Markets,"
Research Papers
1854, Stanford University, Graduate School of Business.
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