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Aggregation of Information and Beliefs: Asset Pricing Lessons from Prediction Markets

Author

Listed:
  • Marco Ottaviani

    (Kellogg School of Management, Northwestern University)

  • Peter Norman Sørensen

    (Department of Economics, University of Copenhagen)

Abstract

In a binary prediction market in which risk-neutral traders have heterogeneous prior beliefs and are allowed to invest a limited amount of money, the static rational expectations equilibrium price is demonstrated to underreact to information. This effect is consistent with a favorite-longshot bias, and is more pronounced when prior beliefs are more heterogeneous. Relaxing the assumptions of risk neutrality and bounded budget, underreaction to information also holds in a more general asset market with heterogeneous priors, provided traders have decreasing absolute risk aversion. In a dynamic asset market, the underreaction of the first period price is followed by momentum.

Suggested Citation

  • Marco Ottaviani & Peter Norman Sørensen, 2009. "Aggregation of Information and Beliefs: Asset Pricing Lessons from Prediction Markets," Discussion Papers 09-14, University of Copenhagen. Department of Economics.
    • Handle: RePEc:kud:kuiedp:0914
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    File URL: http://www.econ.ku.dk/english/research/publications/wp/dp_2009/0914.pdf/
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    References listed on IDEAS

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    Cited by:

    1. Samuel M. Hartzmark & David H. Solomon, 2012. "Efficiency and the Disposition Effect in NFL Prediction Markets," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 2(03), pages 1-42.
    2. Xavier Vives & Giovanni Cespa, 2011. "Higher Order Expectations, Illiquidity, and Short Term Trading," 2011 Meeting Papers 929, Society for Economic Dynamics.
    3. Giovanni Cespa & Xavier Vives, 2012. "Dynamic Trading and Asset Prices: Keynes vs. Hayek," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 79(2), pages 539-580.
    4. Cimadomo, Jacopo & Claeys, Peter & Poplawski-Ribeiro, Marcos, 2016. "How do experts forecast sovereign spreads?," European Economic Review, Elsevier, vol. 87(C), pages 216-235.
    5. G. Bottazzi & D. Giachini, 2019. "Far from the madding crowd: collective wisdom in prediction markets," Quantitative Finance, Taylor & Francis Journals, vol. 19(9), pages 1461-1471, September.
    6. Claeys, Peter & Cimadomo, Jacopo & Poplawski Ribeiro, Marcos, 2014. "How do financial institutions forecast sovereign spreads?," Working Paper Series 1750, European Central Bank.
    7. repec:grz:wpsses:2019-01 is not listed on IDEAS

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    More about this item

    Keywords

    prediction markets; private information; heterogeneous prior beliefs; limited budget; underreaction;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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