Modeling volatility in prediction markets

There is significant experimental evidence that prediction markets are efficient mechanisms for aggregating information and are more accurate in forecasting events than traditional forecasting methods, such as polls. Interpretation of prediction market prices as probabilities has been extensively studied in the literature. However there is little research on the volatility of prediction market prices. Given that volatility is fundamental in estimating significance of price movements, it is important to have a better understanding of the volatility of the contract prices. This paper presents a model of a prediction market with binary payoff on a competitive event involving two parties. In our model, each party has a latent underlying “ability” process that describes its ability to win and evolves as an Ito diffusion. We show that, if the prediction market for this event is efficient and unbiased, the price of the corresponding contract also follows a diffusion and its instanta...

• Type: Conference
• Year: 2009
• Where: SIGECOM
• Authors: Nikolay Archak, Panagiotis G. Ipeirotis
• Keywords: Future Contract Volatility, Information Management, Prediction Market, Prediction Market Prices, SIGECOM 2009