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On the Observational Implications of Knightian Uncertainty

Author

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  • Hassett Kevin A.

    (Hoover Institution, Stanford University, Stanford, 94305, CA, USA)

  • Zhong Weifeng

    (Mercatus Center, George Mason University, Arlington, 22201, VA, USA)

Abstract

We develop a model of a prediction market with ambiguity and derive testable implications of the presence of Knightian uncertainty. Our model can also explain two commonly observed empirical regularities in betting markets: the tendency for longshots to win less often than odds would indicate and the tendency for favorites to win more often. Using historical data from Intrade, we further present empirical evidence that is consistent with the predicted presence of Knightian uncertainty. Our evidence also suggests that, even with information acquisition, the Knightian uncertainty of the world may be not “learnable” to the traders in prediction markets.

Suggested Citation

  • Hassett Kevin A. & Zhong Weifeng, 2021. "On the Observational Implications of Knightian Uncertainty," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 21(1), pages 115-147, January.
    • Handle: RePEc:bpj:bejtec:v:21:y:2021:i:1:p:115-147:n:10
    DOI: 10.1515/bejte-2019-0070
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    More about this item

    Keywords

    ambiguity; Knightian uncertainty; prediction market; maxmin preferences;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • L83 - Industrial Organization - - Industry Studies: Services - - - Sports; Gambling; Restaurants; Recreation; Tourism

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