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Prediction market prices under risk aversion and heterogeneous beliefs

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  • He, Xue-Zhong
  • Treich, Nicolas

Abstract

In this paper, we examine the properties of prediction market prices when risk averse traders have heterogeneous beliefs in state probabilities. We show that the equilibrium state prices equal the mean beliefs of traders about that state if and only if the traders’ common utility function is logarithmic. We also provide a necessary and sufficient condition ensuring that the state prices are systematically below or above the mean beliefs of traders, thus providing a rational explanation to the favorite-longshot bias in prediction markets.

Suggested Citation

  • He, Xue-Zhong & Treich, Nicolas, 2017. "Prediction market prices under risk aversion and heterogeneous beliefs," Journal of Mathematical Economics, Elsevier, vol. 70(C), pages 105-114.
    • Handle: RePEc:eee:mateco:v:70:y:2017:i:c:p:105-114
    DOI: 10.1016/j.jmateco.2017.02.005
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    3. Angelini, Giovanni & De Angelis, Luca & Singleton, Carl, 2022. "Informational efficiency and behaviour within in-play prediction markets," International Journal of Forecasting, Elsevier, vol. 38(1), pages 282-299.
    4. Marco Mantovani & Antonio Filippin, 2024. "When do prediction markets return average beliefs? Experimental evidence," Working Papers 532, University of Milano-Bicocca, Department of Economics.
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    6. Razvan Tarnaud, 2019. "Convergence within binary market scoring rules," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 68(4), pages 1017-1050, November.

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