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

Publikation: Working paperForskning

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Marco Ottaviani, Peter Norman Sørensen

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.
OriginalsprogEngelsk
UdgiverDepartment of Economics, University of Copenhagen
StatusUdgivet - 2009

Bibliografisk note

JEL classification: D82, D83, D84

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