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 ma...

We develop a rational expectations equilibrium model in which noise trading comes from discretionary liquidity traders. The equilibrium quantity of aggregate noise trading is endogenously determined by the population size of liquidity traders active in the financial market. By improving market liquidity, public information reduces the expected trading loss of liquidity traders and thus attracts...

These notes consider Abreu and Brunnermeier’s (2003) paper on the failure of rational arbitrage in asset markets. Recall that the “no-trade” theorem states that speculative bubbles cannot exist in a world with only rational traders even if there is asymmetric information, so long as these traders share a common prior. Believers in the efficient market hypothesis argue that even if there are als...

We investigate the limiting behavior of trader wealth and prices in a simple prediction market with a finite set of participants having heterogeneous beliefs. Traders bet repeatedly on the outcome of a binary event with fixed Bernoulli success probability. A class of strategies, including (fractional) Kelly betting and constant relative risk aversion (CRRA) are considered. We show that when tra...

Rational herd is usually regarded to be difficult, if not impossible, to take place in an efficient financial market. In an extension of a sequential unit trading model, we find that large numbers of inferiorly informed traders who used not to trade could be induced to engage in herding when there are only a few uninformed traders adopting feedback strategies. We show conditions under which dif...

This paper examines the impact of conservative traders on market efficiency in an evolutionary model of a commodity futures market. This paper shows that the long-run market outcome is informationally efficient, as long as in every period there is a positive probability that entering traders are more conservative than their predecessors. Conservative traders are those who correctly predict the ...

In this paper we study the design and characterization of prediction markets in the presence of traders with unknown risk-aversion. We formulate a series of desirable properties for any “market-like” forecasting mechanism. We present a randomized mechanism that satisfies all these properties while guaranteeing that it is myopically optimal for each trader to trade honestly, regardless of her de...

Classical approaches to traders in middleware rely on a common language of server, clients, and traders to understand each other. In these systems, pre-defined ontologies play a crucial role. But when dealing with large-scale, open systems such ontologies are no longer available. To cope with this problem, we have developed a radically different approach to trading. Rather than relying 100% on ...

A simple trading model based on pair pattern strategy space with holding periods is proposed. Power-law behaviors are observed for the return variance σ, the price impact H and the predictability K for both models with linear and square root impact functions. The sum of the traders’ wealth displays a positive value for the model with square root price impact function, and a qualitative explanat...

A longstanding controversy in economics and finance is whether financial markets are governed by rational forces or by emotional responses. We study the importance of emotion in the decision-making process of professional securities traders by measuring their physiological characteristics (e.g., skin conductance, blood volume pulse, etc.) during live trading sessions while simultaneously captur...