Betting Strategies, Market Selection, and the Wisdom of Crowds

7 Pages Posted: 22 Feb 2014

See all articles by Willemien Kets

Willemien Kets

University of Oxford - Department of Economics

David M. Pennock

Microsoft Corporation - Microsoft Research, New York City

Rajiv Sethi

Barnard College, Columbia University; Santa Fe Institute

Nisarg Shah

Carnegie Mellon University

Date Written: February 20, 2014

Abstract

We investigate the limiting behavior of trader wealth and prices in a simple prediction market with a finite set of participants having heterogeneous beliefs. Traders bet repeatedly on the outcome of a binary event with fixed Bernoulli success probability. A class of strategies, including (fractional) Kelly betting and constant relative risk aversion (CRRA) are considered. We show that when traders are willing to risk only a small fraction of their wealth in any period, belief heterogeneity can persist indefinitely; if bets are large in proportion to wealth then only the most accurate belief type survives. The market price is more accurate in the long run when traders with less accurate beliefs also survive. That is, the survival of traders with heterogeneous beliefs, some less accurate than others, allows the market price to better reflect the objective probability of the event in the long run.

Keywords: Prediction Markets, Kelly Betting, Risk Aversion

JEL Classification: D53, D84, G14

Suggested Citation

Kets, Willemien and Pennock, David M. and Sethi, Rajiv and Shah, Nisarg, Betting Strategies, Market Selection, and the Wisdom of Crowds (February 20, 2014). Available at SSRN: https://ssrn.com/abstract=2399075 or http://dx.doi.org/10.2139/ssrn.2399075

Willemien Kets

University of Oxford - Department of Economics ( email )

10 Manor Rd
Oxford, OX1 3UQ
United Kingdom

HOME PAGE: http://wkets.org

David M. Pennock

Microsoft Corporation - Microsoft Research, New York City ( email )

641 Avenue of Americas
New York, NY 10011
United States

Rajiv Sethi (Contact Author)

Barnard College, Columbia University ( email )

3009 Broadway
New York, NY 10027
United States
212-854-5140 (Phone)

HOME PAGE: http://www.columbia.edu/~rs328/

Santa Fe Institute

1399 Hyde Park Road
Santa Fe, NM 87501
United States

Nisarg Shah

Carnegie Mellon University ( email )

Pittsburgh, PA 15213-3890
United States

HOME PAGE: http://www.cs.cmu.edu/~nkshah/

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