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35
Herding and Contrarian Behavior in Financial Markets  An Internet Experiment
, 2002
"... We report results of an internet experiment designed to test the theory of informational cascades in financial markets. More than 6000 subjects, including a subsample of 267 consultants from an international consulting firm, participated in the experiment. As predicted by theory, we find that the pr ..."
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Cited by 38 (6 self)
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We report results of an internet experiment designed to test the theory of informational cascades in financial markets. More than 6000 subjects, including a subsample of 267 consultants from an international consulting firm, participated in the experiment. As predicted by theory, we find that the presence of a flexible market price prevents herding. However, the presence of contrarian behavior, which can (partly) be rationalized via error models, distorts prices, and even after 20 decisions convergence to the fundamental value is rare. We also study the effects of transaction costs and the expectations of subjects with respect to future prices. Finally, we look at the behavior of various subsamples of our heterogeneous subject pool.
A dynamic parimutuel market for hedging, wagering, and information aggregation
 In Proceedings of the Fifth ACM Conference on Electronic Commerce (EC’04
, 2004
"... I develop a new mechanism for risk allocation and information speculation called a dynamic parimutuel market (DPM). A DPM acts as hybrid between a parimutuel market and a continuous double auction (CDA), inheriting some of the advantages of both. Like a parimutuel market, a DPM offers infinite bu ..."
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Cited by 34 (7 self)
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I develop a new mechanism for risk allocation and information speculation called a dynamic parimutuel market (DPM). A DPM acts as hybrid between a parimutuel market and a continuous double auction (CDA), inheriting some of the advantages of both. Like a parimutuel market, a DPM offers infinite buyin liquidity and zero risk for the market institution; like a CDA, a DPM can continuously react to new information, dynamically incorporate information into prices, and allow traders to lock in gains or limit losses by selling prior to event resolution. The trader interface can be designed to mimic the familiar double auction format with bidask queues, though with an addition variable called the payoff per share. The DPM price function can be viewed as an automated market maker always offering to sell at some price, and moving the price appropriately according to demand. Since the mechanism is parimutuel (i.e., redistributive), it is guaranteed to pay out exactly the amount of money taken in. I explore a number of variations on the basic DPM, analyzing the properties of each, and solving in closed form for their respective price functions.
Extracting Collective Probabilistic Forecasts from Web Games
, 2001
"... Game sites on the World Wide Web draw people from around the world with specialized interests, skills, and knowledge. ..."
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Cited by 30 (10 self)
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Game sites on the World Wide Web draw people from around the world with specialized interests, skills, and knowledge.
Betting BooleanStyle: A Framework for Trading in Securities Based on Logical Formulas
, 2003
"... We develop a framework for trading in compound securities: financial instruments that pay off contingent on the outcomes of arbitrary statements in propositional logic. Buying or selling securities  which can be thought of as betting on or against a particular future outcome  allows agents both ..."
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Cited by 30 (17 self)
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We develop a framework for trading in compound securities: financial instruments that pay off contingent on the outcomes of arbitrary statements in propositional logic. Buying or selling securities  which can be thought of as betting on or against a particular future outcome  allows agents both to hedge risk and to profit (in expectation) on subjective predictions. A compound securities market allows agents to place bets on arbitrary boolean combinations of events, enabling them to more closely achieve their optimal risk exposure, and enabling the market as a whole to more closely achieve the social optimum. The tradeoff for allowing such expressivity is in the complexity of the agents' and auctioneer's optimization problems.
Computation in a Distributed Information Market
, 2003
"... According to economic theory, supported by empirical and laboratory evidence, the equilibrium price of a financial security reflects all of the information regarding the security's value. We investigate the dynamics of the computational process on the path toward equilibrium, where information dis ..."
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Cited by 21 (4 self)
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According to economic theory, supported by empirical and laboratory evidence, the equilibrium price of a financial security reflects all of the information regarding the security's value. We investigate the dynamics of the computational process on the path toward equilibrium, where information distributed among traders is revealed stepby step over time and incorporated into the market price. We develop a simplified model of an information market, along with trading strategies, in order to formalize the computational properties of the process. We show that securities whose payoffs cannot be expressed as a weighted threshold function of distributed input bits are not guaranteed to converge to the proper equilibrium predicted by economic theory. On the other hand, securities whose payoffs are threshold functions are guaranteed to converge, for all prior probability distributions. Moreover, these threshold securities converge in at most n rounds, where n is the number of bits of distributed information. We also prove a lower bound, showing a type of threshold security that requires at least n/2 rounds to converge in the worst case.
A parimutuel market microstructure for contingent claims’, at http://www.stern.nyu.edu/networks/Parimutuel.pdf
, 2003
"... Parimutuel principles are widely used as an alternative to fixed odds gambling in which a bookmaker acts as a dealer by quoting fixed rates of return on specified wagers. A parimutuel game is conducted as a call auction in which odds are allowed to fluctuate during the betting period until the betti ..."
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Cited by 15 (0 self)
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Parimutuel principles are widely used as an alternative to fixed odds gambling in which a bookmaker acts as a dealer by quoting fixed rates of return on specified wagers. A parimutuel game is conducted as a call auction in which odds are allowed to fluctuate during the betting period until the betting period is closed or the auction ‘called’. The prices or odds of wagers are set based upon the relative amounts wagered on each risky outcome. In financial microstructure terms, trading under parimutuel principles is characterised by (1) call auction, noncontinuous trading; (2) riskless funding of claim payouts using the amounts paid for all of the claims during the auction; (3) special equilibrium pricing conditions requiring the relative prices of contingent claims equal the relative aggregate amounts wagered on such claims; (4) endogenous determination of unique state prices; and (5) higher efficiency. Recently, a number of large investment banks have adopted a parimutuel mechanism for offering contingent claims on various economic indices, such as the US Nonfarm payroll report and Eurozone Harmonised inflation. Our paper shows how the market microstructure incorporating parimutuel principles for contingent claims which allows for notional transactions, limit orders, and bundling of claims across states is constructed. We prove the existence of a unique price equilibrium for such a market and suggest an algorithm for computing the equilibrium. We also suggest that for a broad class of contingent claims, that the parimutuel microstructure recently deployed offers many advantages over the dominant dealer and exchange continuous time mechanisms.
2005), “Risk Aversion, Beliefs, and Prediction Market Equilibrium”, mimeo
"... Manski [2004] analyzes the relationship between the distribution of traders ’ beliefs and the equilibrium price in a prediction market with risk neutral traders. He finds that there can be a substantial difference between the mean belief that an event will occur, and the price of an asset that pays ..."
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Cited by 11 (0 self)
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Manski [2004] analyzes the relationship between the distribution of traders ’ beliefs and the equilibrium price in a prediction market with risk neutral traders. He finds that there can be a substantial difference between the mean belief that an event will occur, and the price of an asset that pays one dollar if the event occurs and otherwise pays nothing. This result is puzzling, since these markets frequently produce excellent predictions. This paper resolves the apparent puzzle by demonstrating that both risk aversion and the distribution of traders ’ beliefs significantly affect the equilibrium price. For coefficients of relative risk aversion near those estimated in empirical studies and for plausible belief distributions, the equilibrium price is very near the traders ’ mean belief. Prediction markets have been used frequently to estimate the probability of future events. In 1988 the Iowa Political Stock Market predicted the outcome of the U.S. presidential election more accurately than all major polls. (See Forsythe, Nelson, Neumann, and Wright
The power of play: Efficiency and forecast accuracy in web market games
 NEC RESEARCH INSTITUTE
, 2000
"... We analyze the eciency and forecast accuracy of two market games on the World Wide Web: the Hollywood Stock Exchange (HSX) and the Foresight Exchange (FX). We quantify the degree of arbitrage available on HSX, and compare with a realmoney market of a similar nature. We show that prices of HSX movie ..."
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Cited by 11 (1 self)
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We analyze the eciency and forecast accuracy of two market games on the World Wide Web: the Hollywood Stock Exchange (HSX) and the Foresight Exchange (FX). We quantify the degree of arbitrage available on HSX, and compare with a realmoney market of a similar nature. We show that prices of HSX movie stocks provide good forecasts of actual box oce returns, and that prices of HSX securities in Oscar, Emmy, and Grammy award outcomes constitute accurate assessments of the actual likelihoods that nominees will win. Similar investigations reveal that FX securities prices serve as reliable indicators of uncertain future events. We argue that, in certain circumstances, market simulations can furnish some of the same societal benets as real markets, and can serve as acceptable substitute testbeds for conducting experiments that would otherwise be dicult or impossible.
Modeling Information Incorporation in Markets, with Application to Detecting and Explaining Events
, 2002
"... We develop a model of how information flows into a market, and derive algorithms for automatically detecting and explaining relevant events. We analyze data from twentytwo "political stock markets" (i.e., betting markets on political outcomes) on the Iowa Electronic Market (IEM). We prove that, und ..."
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Cited by 10 (4 self)
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We develop a model of how information flows into a market, and derive algorithms for automatically detecting and explaining relevant events. We analyze data from twentytwo "political stock markets" (i.e., betting markets on political outcomes) on the Iowa Electronic Market (IEM). We prove that, under certain eciency assumptions, prices in such betting markets will on average approach the correct outcomes over time, and show that IEM data conforms closely to the theory. We present a simple model of a betting market where information is revealed over time, and show a qualitative correspondence between the model and real market data. We also present an algorithm for automatically detecting significant events and generating semantic explanations of their origin. The algorithm operates by discovering significant changes in vocabulary on online news sources (using expected entropy loss) that align with major price spikes in related betting markets.
Supervised Aggregation of Classifiers using Artificial Prediction Markets
"... Prediction markets are used in real life to predict outcomes of interest such as presidential elections. In this work we introduce a mathematical theory for Artificial Prediction Markets for supervised classifier aggregation and probability estimation. We introduce the artificial prediction market a ..."
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Cited by 7 (2 self)
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Prediction markets are used in real life to predict outcomes of interest such as presidential elections. In this work we introduce a mathematical theory for Artificial Prediction Markets for supervised classifier aggregation and probability estimation. We introduce the artificial prediction market as a novel way to aggregate classifiers. We derive the market equations to enforce total budget conservation, show the market price uniqueness and give efficient algorithms for computing it. We show how to train the market participants by updating their budgets using training examples. We introduce classifier specialization as a new differentiating characteristic between classifiers. Finally, we present experiments using random decision rules as specialized classifiers and show that the prediction market consistently outperforms Random Forest on real and synthetic data of varying degrees of difficulty. 1.