Interpreting the Predictions of Prediction Markets

14 Pages Posted: 23 Mar 2004 Last revised: 3 Sep 2009

See all articles by Charles F. Manski

Charles F. Manski

Northwestern University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: March 2004

Abstract

Participants in prediction markets such as the Iowa Electronic Markets trade all-or-nothing contracts that pay a dollar if and only if specified future events occur. Researchers engaged in empirical study of prediction markets have argued broadly that equilibrium prices of the contracts traded are market probabilities' that the specified events will occur. This paper shows that if traders are risk-neutral price takers with heterogenous beliefs, the price of a contract in a prediction market reveals nothing about the dispersion of traders' beliefs and partially identifies the central tendency of beliefs. Most persons have beliefs higher than price when price is above 0.5, and most have beliefs lower than price when price is below 0.5. The mean belief of traders lies in an interval whose midpoint is the equilibrium price. These findings persist even if traders use price data to revise their beliefs in plausible ways.

Suggested Citation

Manski, Charles F., Interpreting the Predictions of Prediction Markets (March 2004). NBER Working Paper No. w10359, Available at SSRN: https://ssrn.com/abstract=515253

Charles F. Manski (Contact Author)

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