The Informational Content of the Limit Order Book: An Empirical Study of Prediction Markets

TL;DR

This paper empirically examines prediction markets for binary options, testing if prices reflect true probabilities and if markets reach consensus, finding limited evidence of belief convergence and that belief estimates often remain ambiguous.

Contribution

It introduces an econometric approach to estimate market consensus beliefs from order data, revealing the difficulty in deriving definitive probability estimates from prediction market prices.

Findings

Little evidence of belief convergence in prediction markets

Order submission data can only provide ambiguous belief bounds

Market prices often do not reflect a consensus probability

Abstract

In this paper I empirically investigate prediction markets for binary options. Advocates of prediction markets have suggested that asset prices are consistent estimators of the "true" probability of a state of the world being realized. I test whether the market reaches a "consensus." I find little evidence for convergence in beliefs. I then determine whether an econometrician using data beyond execution prices can leverage this data to estimate the consensus belief. I use an incomplete specification of equilibrium outcomes to derive bounds on beliefs from order submission decisions. Interval estimates of mean beliefs cannot exclude aggregate beliefs equal to 0.5.