Year: 2012
Type: article
Abstract: This article presents new theoretical and empirical evidence on the forecasting ability of prediction markets. We develop a model that predicts that the time until expiration of a prediction market should negatively affect the accuracy of prices as a forecasting tool in the direction of a ‘favourite/longshot bias’. That is, high‐likelihood events are underpriced, and low‐likelihood events are over‐priced. We confirm this result using a large data set of prediction market transaction prices. Prediction markets are reasonably well calibrated when time to expiration is relatively short, but prices are significantly biased for events farther in the future. When time value of money is considered, the miscalibration can be exploited to earn excess returns only when the trader has a relatively low discount rate.
Source: The Economic Journal
Authors: Lionel Page, Robert T. Clemen
Institutions: Queensland University of Technology, Duke University
Language: English
Subfield: Economics and Econometrics
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W1937068864