FOREGONE INTEREST AND CONTRACT MISPRICING IN PREDICTIVE MARKETS

Over the past 20 years, predictive markets have risen from relative obscurity to prominence. Relevant across several fields of study, these markets have utilized collective wisdom in order to better ascertain outcomes of future events. This paper look at the mechanics of trading and finds enduring pricing anomalies based on errant behavior on behalf of both buyers and sellers. Specifically, trading behavior seems to ignore the time value of money associated with buying and selling contracts even when the interest foregone is non-trivial. As such, the possibility for arbitrage presents itself in some of these cases. Finally, we examine the associated consequences of this behavior in regards to the mechanics of these markets and possible strengthening reforms in hopes of developing deeper, more robust predictions markets.The authors would like to thank Andrew de los Reyes and David Gordon for their help with research.  In addition, we would like to thank Professor Michael Abramowicz for helpful comments

Forgone Interest and Contract Mispricing in Predictive Markets

Over the past 20 years, predictive markets have risen from relative obscurity to prominence. Relevant across several fields of study, these markets have utilized collective wisdom in order to better ascertain outcomes of future events. This paper look at the mechanics of trading and finds enduring pricing anomalies based on errant behavior on behalf of both buyers and sellers. Specifically, trading behavior seems to ignore the time value of money associated with buying and selling contracts even when the interest forgone is non-trivial. As such, the possibility for arbitrage presents itself in some of these cases. Finally, we examine the associated consequences of this behavior in regards to the mechanics of these markets and possible strengthening reforms in hopes of developing deeper, more robust predictions markets.