Risk Aversion, Beliefs, and Prediction Market Equilibrium

Steven Gjerstad ()

Microeconomics from EconWPA

Abstract: Manski [2004] analyzes the relationship between the distribution of traders’ beliefs and the equilibrium price in a prediction market with risk neutral traders. He finds that there can be a substantial difference between the mean belief that an event will occur, and the price of an asset that pays one dollar if the event occurs and otherwise pays nothing. This result is puzzling, since these markets frequently produce excellent predictions. This paper resolves the apparent puzzle by demonstrating that both risk aversion and the distribution of traders’ beliefs significantly affect the equilibrium price. For coeffcients of relative risk aversion near those estimated in empirical studies and for plausible belief distributions, the equilibrium price is very near the traders’ mean belief.

Keywords: Asset pricing; beliefs; competitive equilibrium; prediction markets; risk aversion (search for similar items in EconPapers)
JEL-codes: C92 D84 G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn
Date: 2004-11-04
Note: Type of Document - pdf; pages: 17
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpmi:0411002

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