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Heterogeneous Beliefs and Prediction Market Accuracy

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  • He, Xue-Zhong
  • Treich, Nicolas

Abstract

We consider a prediction market in which traders have heterogeneous prior beliefs in probabilities. In the two-state case, we derive necessary and sufficient conditions so that the prediction market is accurate in the sense that the equilibrium state price equals the mean probabilities of traders' beliefs. We also provide a necessary and sufficient condition for the well documented favorite-longshot bias. In an extension to many states, we revisit the results of Varian (1985) on the relationship between equilibrium state price and belief heterogeneity.

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Paper provided by Toulouse School of Economics (TSE) in its series TSE Working Papers with number 13-394.

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Date of creation: 20 Aug 2012
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Handle: RePEc:tse:wpaper:27155

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Keywords: Prediction market; heterogeneous beliefs; risk aversion; favorite-longshot bias; complete markets; and asset prices.;

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  1. Jouini, Elyès & Napp, Clotilde, 2007. "Consensus Consumer and Intertemporal Asset Pricing with Heterogeneous Beliefs," Economics Papers from University Paris Dauphine 123456789/78, Paris Dauphine University.
  2. Ely�s Jouini & Clotilde Napp, 2007. "Consensus Consumer and Intertemporal Asset Pricing with Heterogeneous Beliefs," Review of Economic Studies, Oxford University Press, vol. 74(4), pages 1149-1174.
  3. Elyès Jouini & Clotilde Napp, 2006. "Aggregation of Heterogeneous Beliefs," Post-Print halshs-00176505, HAL.
  4. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
  5. Christian Gollier, 2007. "Whom should we believe? Aggregation of heterogeneous beliefs," Journal of Risk and Uncertainty, Springer, vol. 35(2), pages 107-127, October.
  6. Hong, Harrison & Stein, Jeremy, 2007. "Disagreement and the Stock Market," Scholarly Articles 2894690, Harvard University Department of Economics.
  7. Peter C. Fishburn & R. Burr Porter, 1976. "Optimal Portfolios with One Safe and One Risky Asset: Effects of Changes in Rate of Return and Risk," Management Science, INFORMS, vol. 22(10), pages 1064-1073, June.
  8. Andrew B. Abel, . "Asset Prices Under Heterogenous Beliefs: Implications for the Equity Premium," Rodney L. White Center for Financial Research Working Papers 9-89, Wharton School Rodney L. White Center for Financial Research.
  9. Wolfers, Justin & Zitzewitz, Eric, 2006. "Interpreting Prediction Market Prices as Probabilities," CEPR Discussion Papers 5676, C.E.P.R. Discussion Papers.
  10. John Fountain & Glenn Harrison, 2011. "What do prediction markets predict?," Applied Economics Letters, Taylor & Francis Journals, vol. 18(3), pages 267-272.
  11. Manski, Charles F., 2006. "Interpreting the predictions of prediction markets," Economics Letters, Elsevier, vol. 91(3), pages 425-429, June.
  12. Steven Gjerstad, 2004. "Risk Aversion, Beliefs, and Prediction Market Equilibrium," Microeconomics 0411002, EconWPA.
  13. Varian, Hal R, 1985. " Divergence of Opinion in Complete Markets: A Note," Journal of Finance, American Finance Association, vol. 40(1), pages 309-17, March.
  14. Forsythe, Robert & Forrest Nelson & George R. Neumann & Jack Wright, 1992. "Anatomy of an Experimental Political Stock Market," American Economic Review, American Economic Association, vol. 82(5), pages 1142-61, December.
  15. Napp, Clotilde & Jouini, Elyès, 2006. "Aggregation of Heterogeneous Beliefs," Economics Papers from University Paris Dauphine 123456789/80, Paris Dauphine University.
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