It takes all sorts: a heterogeneous agent explanation for prediction market mispricing
It takes all sorts: a heterogeneous agent explanation for prediction market mispricing
Pricing anomalies threaten the value of prediction markets as a means of harnessing the ’wisdom of the crowd’ to make accurate forecasts. The most persistent and puzzling pricing anomaly associated with price-implied prediction probabilities is the favourite-longshot bias (FLB). We demonstrate that existing models of the FLB fail to capture its full complexity, thereby preventing appropriate adjustments to market forecasts to improve their accuracy. We develop an agent-based model with heterogeneous agents in a fixed-odds market. Our agent-based simulations and comprehensive analysis using market data demonstrate that our model explains real market behaviour, including that of market makers, better than existing theories. Importantly, our results suggest that adequately complex models are necessary to describe complex phenomena such as pricing anomalies. We discuss how our model can be used to better understand the relation between market ecology and mispricing in contexts such as options and prediction markets, consequently enhancing their predictive power.
556-569
Restocchi, Valerio
39654f4e-2a84-4c78-a853-081704568415
McGroarty, Frank
693a5396-8e01-4d68-8973-d74184c03072
Gerding, Enrico
d9e92ee5-1a8c-4467-a689-8363e7743362
Johnson, Johnnie E.V.
6d9f1a51-38a8-4011-a792-bfc82040fac4
16 October 2018
Restocchi, Valerio
39654f4e-2a84-4c78-a853-081704568415
McGroarty, Frank
693a5396-8e01-4d68-8973-d74184c03072
Gerding, Enrico
d9e92ee5-1a8c-4467-a689-8363e7743362
Johnson, Johnnie E.V.
6d9f1a51-38a8-4011-a792-bfc82040fac4
Restocchi, Valerio, McGroarty, Frank, Gerding, Enrico and Johnson, Johnnie E.V.
(2018)
It takes all sorts: a heterogeneous agent explanation for prediction market mispricing.
European Journal of Operational Research, 270 (2), .
(doi:10.1016/j.ejor.2018.04.011).
Abstract
Pricing anomalies threaten the value of prediction markets as a means of harnessing the ’wisdom of the crowd’ to make accurate forecasts. The most persistent and puzzling pricing anomaly associated with price-implied prediction probabilities is the favourite-longshot bias (FLB). We demonstrate that existing models of the FLB fail to capture its full complexity, thereby preventing appropriate adjustments to market forecasts to improve their accuracy. We develop an agent-based model with heterogeneous agents in a fixed-odds market. Our agent-based simulations and comprehensive analysis using market data demonstrate that our model explains real market behaviour, including that of market makers, better than existing theories. Importantly, our results suggest that adequately complex models are necessary to describe complex phenomena such as pricing anomalies. We discuss how our model can be used to better understand the relation between market ecology and mispricing in contexts such as options and prediction markets, consequently enhancing their predictive power.
Text
it_takes_all_sorts_accepted paper
- Accepted Manuscript
More information
Submitted date: 26 March 2018
Accepted/In Press date: 12 April 2018
e-pub ahead of print date: 12 April 2018
Published date: 16 October 2018
Identifiers
Local EPrints ID: 419718
URI: http://eprints.soton.ac.uk/id/eprint/419718
ISSN: 0377-2217
PURE UUID: 497b461e-0389-41e6-8438-e53ad661bebf
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Date deposited: 20 Apr 2018 16:30
Last modified: 16 Mar 2024 06:30
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Contributors
Author:
Valerio Restocchi
Author:
Frank McGroarty
Author:
Enrico Gerding
Author:
Johnnie E.V. Johnson
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