Do Prediction Markets Produce Well‐Calibrated Probability Forecasts?

23 Pages Posted: 28 Apr 2013

See all articles by Lionel Page

Lionel Page

Queensland University of Technology

Robert T. Clemen

Duke University

Date Written: May 2013

Abstract

This article presents new theoretical and empirical evidence on the forecasting ability of prediction markets. We develop a model that predicts that the time until expiration of a prediction market should negatively affect the accuracy of prices as a forecasting tool in the direction of a ‘favourite/longshot bias’. That is, high‐likelihood events are underpriced, and low‐likelihood events are over‐priced. We confirm this result using a large data set of prediction market transaction prices. Prediction markets are reasonably well calibrated when time to expiration is relatively short, but prices are significantly biased for events farther in the future. When time value of money is considered, the miscalibration can be exploited to earn excess returns only when the trader has a relatively low discount rate.

Suggested Citation

Page, Lionel and Clemen, Robert T., Do Prediction Markets Produce Well‐Calibrated Probability Forecasts? (May 2013). The Economic Journal, Vol. 123, Issue 568, pp. 491-513, 2013. Available at SSRN: https://ssrn.com/abstract=2257139 or http://dx.doi.org/10.1111/j.1468-0297.2012.02561.x

Lionel Page

Queensland University of Technology ( email )

2 George Street
Brisbane, Queensland 4000
Australia

Robert T. Clemen

Duke University ( email )

100 Fuqua Drive
Durham, NC 27708-0204
United States

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