Informational Efficiency of Decision Markets with Risk-Averse Insiders and Uncertain Manipulation

Date of Award

2010

Document Type

Thesis

Degree Name

Bachelors

Department

Social Sciences

First Advisor

Elliot, Catherine

Keywords

Prediction Markets, Market Microstructure, Information Aggregation

Area of Concentration

Economics

Abstract

I examine the informational efficiency of prices in low-volume speculative markets under a variety of conditions involving price manipulation. I construct a market microstructure model based on the one-period batch-clearing framework of Kyle (1985), probabilistically incorporating a manipulator with preferences over the deviation of an asset price from a privately-known target as well as $N$ profit-maximizing risk-averse traders each receiving a noisy signal of the asset value. I find that the price error is normally distributed with mean zero. For a variety of plausible parameter values, I find that 1) the informed traders bid more aggressively in the presence of manipulation despite the increased risk penalty, 2) the variance of the price error is monotonically increasing in the level of risk aversion and the degree of manipulation, 3) the effectiveness of manipulation is highly sensitive to the size of the market, 4) the introduction of informed traders into the market is subject to a period of increasing returns followed by a period of decreasing returns, and 5) prices aggregate traders' private information even in the presence of a high degree of manipulation when the market is sufficiently thick.

Rights

This bibliographic record is available under the Creative Commons CC0 public domain dedication. The New College of Florida, as creator of this bibliographic record, has waived all rights to it worldwide under copyright law, including all related and neighboring rights, to the extent allowed by law.

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