We consider a prediction market in which traders have heterogeneous prior beliefs in probabilities. In the two-state case, we derive necessary and sufficient conditions so that the prediction market is accurate in the sense that the equilibrium state price equals the mean probabilities of traders' beliefs. We also provide a necessary and sufficient condition for the well documented favorite-longshot bias. In an extension to many states, we revisit the results of Varian (1985) on the relationship between equilibrium state price and belief heterogeneity.
Prediction market; heterogeneous beliefs; risk aversion; favorite-longshot bias; complete markets; and asset prices;
Xue-Zhong He, and Nicolas Treich, “Prediction market prices under risk aversion and heterogeneous beliefs”, Journal of Mathematical Economics, vol. 70, May 2017, pp. 105–114.
TSE Working Paper, n. 13-394, August 20, 2012