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

TY - UNPB

T1 - Aggregation of Information and Beliefs

T2 - Asset Pricing Lessons from Prediction Markets

AU - Ottaviani, Marco

AU - Sørensen, Peter Norman

N1 - JEL classification: D82, D83, D84

PY - 2009

Y1 - 2009

N2 - 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.

AB - 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.

KW - Faculty of Social Sciences

KW - private information

KW - heterogeneous prior beliefs

KW - limited budget

KW - underreaction

M3 - Working paper

BT - Aggregation of Information and Beliefs

PB - Department of Economics, University of Copenhagen

ER -