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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. Wolfers, Justin & Zitzewitz, Eric, 2006. "Interpreting Prediction Market Prices as Probabilities," IZA Discussion Papers 2092, Institute for the Study of Labor (IZA).
  2. Charles F. Manski, 2004. "Interpreting the Predictions of Prediction Markets," NBER Working Papers 10359, National Bureau of Economic Research, Inc.
  3. 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.
  4. Clotilde Napp & Elyès Jouini, 2006. "Aggregation of Heterogeneous Beliefs," Post-Print halshs-00151562, HAL.
  5. Steven Gjerstad, 2004. "Risk Aversion, Beliefs, and Prediction Market Equilibrium," Microeconomics 0411002, EconWPA.
  6. John Fountain & Glenn Harrison, 2011. "What do prediction markets predict?," Applied Economics Letters, Taylor & Francis Journals, vol. 18(3), pages 267-272.
  7. 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.
  8. 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.
  9. Harrison Hong & Jeremy C. Stein, 2007. "Disagreement and the Stock Market," Journal of Economic Perspectives, American Economic Association, vol. 21(2), pages 109-128, Spring.
  10. 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.
  11. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
  12. 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.
  13. Christian Gollier, 2007. "Whom should we believe? Aggregation of heterogeneous beliefs," Journal of Risk and Uncertainty, Springer, vol. 35(2), pages 107-127, October.
  14. Napp, Clotilde & Jouini, Elyès, 2006. "Aggregation of Heterogeneous Beliefs," Economics Papers from University Paris Dauphine 123456789/80, Paris Dauphine University.
  15. 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.
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