Interpreting Prediction Market Prices as Probabilities
AbstractWhile 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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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12200.
Date of creation: May 2006
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Other versions of this item:
- Justin Wolfers & Eric Zitzewitz, 2006. "Interpreting prediction market prices as probabilities," Working Paper Series 2006-11, Federal Reserve Bank of San Francisco.
- Wolfers, Justin & Zitzewitz, Eric, 2006. "Interpreting Prediction Market Prices as Probabilities," IZA Discussion Papers 2092, Institute for the Study of Labor (IZA).
- Wolfers, Justin & Zitzewitz, Eric, 2006. "Interpreting Prediction Market Prices as Probabilities," CEPR Discussion Papers 5676, C.E.P.R. Discussion Papers.
- D4 - Microeconomics - - Market Structure and Pricing
- D8 - Microeconomics - - Information, Knowledge, and Uncertainty
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-05-13 (All new papers)
- NEP-FIN-2006-05-13 (Finance)
- NEP-FMK-2006-05-13 (Financial Markets)
- NEP-RMG-2006-05-13 (Risk Management)
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