Information Exchange in Prediction Markets: How Social Networks Promote Forecast Efficiency

47 Pages Posted: 30 Apr 2012 Last revised: 11 May 2012

See all articles by Liangfei Qiu

Liangfei Qiu

University of Florida - Warrington College of Business Administration

Huaxia Rui

University of Rochester - Simon Business School

Andrew B. Whinston

University of Texas at Austin - Department of Information, Risk and Operations Management

Date Written: May 5, 2012

Abstract

This paper studies the effects of information exchange and social networks on the performance of prediction markets with endogenous information acquisition. We provide a game-theoretic framework to resolve the question: Can social networks and information exchange promote the forecast efficiency in prediction markets? Our study shows that a social network is not a panacea in terms of improving forecast efficiency. The use of social networks could be detrimental to forecast performance when the cost of information acquisition is high. Although social networks can provide internal communications among participants, they reduce the incentive to acquire information because of free riding. We also study the effects of social networks on information acquisition in prediction markets. In the symmetric Bayes-Nash Equilibrium, all participants use a threshold strategy, and the equilibrium action of information acquisition is decreasing in the number of participant's friends and increasing in the network density. The aforementioned results are robust to two commonly used mechanisms of prediction markets: a forecast-report mechanism and a security-trading mechanism.

Keywords: Information Exchange, Prediction Markets, Social Networks

JEL Classification: D83, D85, C72

Suggested Citation

Qiu, Liangfei and Rui, Huaxia and Whinston, Andrew B., Information Exchange in Prediction Markets: How Social Networks Promote Forecast Efficiency (May 5, 2012). Available at SSRN: https://ssrn.com/abstract=2047904 or http://dx.doi.org/10.2139/ssrn.2047904

Liangfei Qiu (Contact Author)

University of Florida - Warrington College of Business Administration ( email )

Gainesville, FL 32611
United States

HOME PAGE: http://sites.google.com/site/qiuliangfei/

Huaxia Rui

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States

Andrew B. Whinston

University of Texas at Austin - Department of Information, Risk and Operations Management ( email )

CBA 5.202
Austin, TX 78712
United States
512-471-8879 (Phone)

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