Lessmann, S., Sung, M. and Johnson, J.E.V.
Towards a methodology for measuring the true degree of efficiency in a speculative market
Journal of the Operational Research Society, 62, . (doi:10.1057/jors.2010.192).
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Betting markets have drawn much attention in the economics, finance and operational research literature
because they provide a valuable window on the manner in which individuals use information in wider
financial markets. One question that has received particular attention is to what extent individuals
discount information in market prices. The predominant approach to explore this issue involves
predictive modeling to forecast market outcomes and examining empirically whether abnormal returns
can be made by employing these forecasts. It is argued here that present practices to assess such
forecasting models, including the use of point estimates and information, which would not be available
in practice (at the forecasting stage) and failing to update forecasting models with information from the
recent past, may give rise to misleading conclusions regarding a market’s informational efficiency.
Hypotheses are developed to conceptualize these views and are tested by means of extensive empirical
experimentation using real-world data from the Hong Kong horserace betting market. Our study
identifies several sources of bias and confirms that current practices may not be relied upon. A more
appropriate modeling procedure for assessing the true degree of market efficiency is then proposed.
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