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Aggregation of Information and Beliefs in Prediction Markets

Author

Listed:
  • Marco Ottaviani

    (London Business School)

  • Peter Norman Sørensen

    (Department of Economics, University of Copenhagen)

Abstract

We analyze a binary prediction market in which traders have heterogeneous prior beliefs and private information. Realistically, we assume that traders are allowed to invest a limited amount of money (or have decreasing absolute risk aversion). We show that the rational expectations equilibrium price underreacts to information. When favorable information to an event is available and is revealed by the market, the price increases and this forces optimists to reduce the number of assets they can (or want to) buy. For the market to equilibrate, the price must increase less than a posterior belief of an outside observer.

Suggested Citation

  • Marco Ottaviani & Peter Norman Sørensen, 2007. "Aggregation of Information and Beliefs in Prediction Markets," FRU Working Papers 2007/01, University of Copenhagen. Department of Economics. Finance Research Unit.
  • Handle: RePEc:kud:kuiefr:200701
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    File URL: http://www.econ.ku.dk/Fru/WorkingPapers/PDF/2007/AIBIPM2.pdf
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    Cited by:

    1. repec:pit:wpaper:489 is not listed on IDEAS
    2. John Fountain & Glenn Harrison, 2011. "What do prediction markets predict?," Applied Economics Letters, Taylor & Francis Journals, vol. 18(3), pages 267-272.
    3. Amos Storkey, 2011. "Machine Learning Markets," Papers 1106.4509, arXiv.org.
    4. Victor Tiberius & Christoph Rasche, 2011. "Prognosemärkte," Metrika: International Journal for Theoretical and Applied Statistics, Springer, vol. 21(4), pages 467-472, April.

    More about this item

    Keywords

    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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