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Improving prediction market forecasts by detecting and correcting possible over-reaction to price movements

Ming-Chien Sung, David C.J. McDonald, Johnnie E.V. Johnson, Chung-Ching Tai and Jeremy Eng Tuck Cheah

European Journal of Operational Research, 2019, vol. 272, issue 1, 389-405

Abstract: We examine the impact of price trends on the accuracy of forecasts from prediction markets. In particular, we study an electronic betting exchange market and construct independent variables from market price (odds) time series from 6058 individual markets (a dataset consisting of over 8.4 million price points). Using a conditional logit model, we find that a systematic relationship exists between trends in odds and the accuracy of odds-implied event probabilities; the relationship is consistent with participants over-reacting to price movements. In particular, in different time segments of the market, increasing and decreasing odds lead, respectively, to under- and over-estimation of odds-implied probabilities. We develop a methodology to detect and correct the erroneous forecasts associated with these trends in odds in order to considerably improve the quality of forecasts generated in prediction markets.

Keywords: Forecasting; Prediction markets; Price signals; Over-reaction (search for similar items in EconPapers)
Date: 2019
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Handle: RePEc:eee:ejores:v:272:y:2019:i:1:p:389-405