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Aggregation of Information and Beliefs: Asset Pricing Lessons from Prediction Markets


  • Marco Ottaviani

    (Kellogg School of Management, Northwestern University)

  • Peter Norman Sørensen

    (Department of Economics, University of Copenhagen)


In a binary prediction market in which risk-neutral traders have heterogeneous prior beliefs and are allowed to invest a limited amount of money, the static rational expectations equilibrium price is demonstrated to underreact to information. This effect is consistent with a favorite-longshot bias, and is more pronounced when prior beliefs are more heterogeneous. Relaxing the assumptions of risk neutrality and bounded budget, underreaction to information also holds in a more general asset market with heterogeneous priors, provided traders have decreasing absolute risk aversion. In a dynamic asset market, the underreaction of the first period price is followed by momentum.

Suggested Citation

  • Marco Ottaviani & Peter Norman Sørensen, 2009. "Aggregation of Information and Beliefs: Asset Pricing Lessons from Prediction Markets," Discussion Papers 09-14, University of Copenhagen. Department of Economics.
  • Handle: RePEc:kud:kuiedp:0914

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    References listed on IDEAS

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    Cited by:

    1. Giovanni Cespa & Xavier Vives, 2012. "Dynamic Trading and Asset Prices: Keynes vs. Hayek," Review of Economic Studies, Oxford University Press, vol. 79(2), pages 539-580.
    2. Cimadomo, Jacopo & Claeys, Peter & Poplawski-Ribeiro, Marcos, 2016. "How do experts forecast sovereign spreads?," European Economic Review, Elsevier, vol. 87(C), pages 216-235.
    3. repec:wsi:qjfxxx:v:02:y:2012:i:03:n:s2010139212500139 is not listed on IDEAS
    4. Cespa, Giovanni & Vives, Xavier, 2011. "Higher order expectations, illiquidity, and short-term trading," IESE Research Papers D/915, IESE Business School.
    5. Claeys, Peter & Cimadomo, Jacopo & Poplawski Ribeiro, Marcos, 2014. "How do financial institutions forecast sovereign spreads?," Working Paper Series 1750, European Central Bank.

    More about this item


    prediction markets; private information; heterogeneous prior beliefs; limited budget; underreaction;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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