Prediction Markets: Reality and Theory

Bristol University, School of Economics, Finance and Management, Accounting and Finance Discussion Paper 16/5

46 Pages Posted: 19 Oct 2016

See all articles by Daniella Acker

Daniella Acker

University of Bristol - Department of Accounting and Finance

Date Written: October 18, 2016

Abstract

Data on individual trades in prediction markets relating to the 2008 and 2012 US Presidential elections reveal that traders vary enormously in their behavior. This contrasts with the standard prediction-market models, which assume relatively homogeneous participants who differ only in their beliefs and wealth. We show that risk-lovers have particularly strong distortionary effects on market outcomes even when beliefs are symmetrically distributed around the truth. Simulations of a model which allows traders to have different motives and tastes for risk indicate that including such traders produce the market outcomes we observe, such as herding, persistent contrariness, a skewed profits’ distribution and favorite-long-shot bias. The attraction of such markets to risk-lovers means that caution must be exercised when using prediction-market prices for forecasting.

Keywords: Prediction markets, Risk-lovers, Herding and contrariness, Favorite-long-shot bias

JEL Classification: G10, G12, G14, G17

Suggested Citation

Acker, Daniella, Prediction Markets: Reality and Theory (October 18, 2016). Bristol University, School of Economics, Finance and Management, Accounting and Finance Discussion Paper 16/5, Available at SSRN: https://ssrn.com/abstract=2854111 or http://dx.doi.org/10.2139/ssrn.2854111

Daniella Acker (Contact Author)

University of Bristol - Department of Accounting and Finance ( email )

12 Priory Road
Bristol, BS8 1TN
United Kingdom
+44 117 394 1476 (Phone)

HOME PAGE: http://www.bristol.ac.uk/efm/people/daniella-e-acker/overview.html

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