Liquidity and Prediction Market Efficiency

49 Pages Posted: 25 Mar 2008 Last revised: 30 Aug 2011

See all articles by Paul C. Tetlock

Paul C. Tetlock

Columbia Business School - Finance

Date Written: May 1, 2008

Abstract

I investigate the relationship between liquidity and market efficiency using data from short horizon binary outcome securities listed on the TradeSports exchange. I find that liquidity does not reduce, and sometimes increases, deviations of prices from financial and sporting event outcomes. One explanation is that limit order traders are naïve about other traders' knowledge and unwittingly bet against them, which can slow the response of prices to information. Consistent with this explanation, the limit orders that execute during informative time periods have negative expected returns; and limit orders often execute against traders who exploit the well-known favorite-longshot bias in prices.

Keywords: Liquidity, Underreaction, Market Efficiency, Prediction Markets, Limits to Arbitrage, Prospect Theory

JEL Classification: G10, G12, G14

Suggested Citation

Tetlock, Paul C., Liquidity and Prediction Market Efficiency (May 1, 2008). Available at SSRN: https://ssrn.com/abstract=929916 or http://dx.doi.org/10.2139/ssrn.929916

Paul C. Tetlock (Contact Author)

Columbia Business School - Finance ( email )

3022 Broadway
New York, NY 10027
United States

HOME PAGE: http://www0.gsb.columbia.edu/faculty/ptetlock/

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