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Longshots, overconfidence and efficiency on the Iowa Electronic Market

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  • Berg, Joyce E.
  • Rietz, Thomas A.

Abstract

We study the forecast accuracy and efficiency of popular “binary” prediction markets. Such markets forecast probabilities for future states of the world (e.g., election winners) by paying off $0 or $1 depending on the realized state (e.g., who actually wins). To assess accuracy, forecast probabilities must be compared to realization frequencies, not individual realizations. We use Iowa Electronic Market (IEM) data to test efficiency against two alternative propositions from behavioral finance: the longshot bias and the overconfidence bias (which yield opposing predictions). No longshot bias appears in IEM markets. Nor does overconfidence influence prices at short horizons. However, overconfident traders may bias prices at intermediate horizons. While the markets are efficient at short horizons, non-market data indicate some intermediate-horizon inefficiency. We calculate Sharpe ratios for static trading strategies and document returns for dynamic trading strategies to assess the economic content of the inefficiencies.

Suggested Citation

  • Berg, Joyce E. & Rietz, Thomas A., 2019. "Longshots, overconfidence and efficiency on the Iowa Electronic Market," International Journal of Forecasting, Elsevier, vol. 35(1), pages 271-287.
    • Handle: RePEc:eee:intfor:v:35:y:2019:i:1:p:271-287
    DOI: 10.1016/j.ijforecast.2018.03.004
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    References listed on IDEAS

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    1. Berg, Joyce & Forsythe, Robert & Nelson, Forrest & Rietz, Thomas, 2008. "Results from a Dozen Years of Election Futures Markets Research," Handbook of Experimental Economics Results, in: Charles R. Plott & Vernon L. Smith (ed.), Handbook of Experimental Economics Results, edition 1, volume 1, chapter 80, pages 742-751, Elsevier.
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    1. Esra Alp Coşkun & Hakan Kahyaoglu & Chi Keung Marco Lau, 2023. "Which return regime induces overconfidence behavior? Artificial intelligence and a nonlinear approach," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 9(1), pages 1-34, December.
    2. Bouteska, Ahmed & Harasheh, Murad & Abedin, Mohammad Zoynul, 2023. "Revisiting overconfidence in investment decision-making: Further evidence from the U.S. market," Research in International Business and Finance, Elsevier, vol. 66(C).

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