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Are prediction markets robust against manipulation? A lab experiment

This research study conducted a lab experiment to examine whether prediction markets are robust against manipulation. The experiment focused on the effects of excessive buying on price predictions. The results suggest that manipulation can have a temporary or durable effect on market prices.

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Are prediction markets robust against manipulation? A lab experiment

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  1. Are prediction markets robust against manipulation? A lab experiment Martin Strobel, University of Maastricht Feb. 2005

  2. Reality Mani- pulator Market Action Price Prediction Prediction Markets: General Idea

  3. Experiment Design: Fundamental Values • Futures traded: BLACK and WHITE • Fundamental values: • BLACK: number of black balls • WHITE: number of white balls • Information:each trader knows a randomly drawn subset 100 balls Trader 1 Trader 2 …

  4. Experimental Design: General Setup • Double auction • Similar to PSMs (bundles = 100 ECU, portfolios were liquidated afterwards for fundamental values) • 8 sessions (S1 … S4 and M1 … M4) • Same instructions for S and M sessions • 12 traders per session (10 for S2 and M2) • Per session 7 markets with 7 minutes duration • Endowment for each market: 1000 ECU and 20 shares either BLACK or WHITE

  5. Experimental Design: Manipulation I • Robot player for manipulation • Focus on one simple method:excessive buying leads to price increases • 90 sec quiet240 sec manipulation90 sec “recovery”(60 sec) Asks Lowest ask+10 Lowest ask Random bid was placed Highest bid Bids

  6. Experimental Design: Manipulation II • Money was spread evenly among future time • Cash of manipulator is limited to 2 * 20 * fund. value (corresponds to an average endowment if value = 50) Asks Lowest ask+10 Lowest ask Random bid was placed Highest bid Bids

  7. Experiment Design: Software

  8. price best case 100 baseline case manipulation case fund. value 100 Expectations

  9. BeforePrice AfterPrice EndPrice • Manipulation has no effect • Manipulation has a temporary effect • Manipulation has a durable effect Hypotheses: Analysis start of market start of manipulation end of manipulation end of market 90 sec 270 sec 60 sec 420 sec

  10. Results

  11. Critique and Preliminary Conclusions • Proof of existence • No final answer to: Are markets vulnerable to manipulation? • 60 sec for recovery time is too short!? • Short-selling would solve the problem!? • After some time traders would incorporate manipulators in their reasoning!?

  12. Further Plans • Varying knowledge, uncertainty, discreteness, … • Allow for short-selling? • Compare results to Hanson, Oprea and Porter (forthcoming)

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