When researchers debate the efficiency of stock markets, one complication is that the true value (as opposed to the price) of a security is almost never revealed with certainty. For example, perhaps my model predicts that IBM shares are worth $110. If I observe that shares are actually trading at $100, I don’t know whether my theories are wrong or whether the market is inefficient.
The true values of prediction market assets, on the other hand, are unambiguously revealed (with few exceptions) upon contract expiry. For instance, Tradesports lists NFL contracts which, once the underlying games end and final scores are observed, are each worth either $0 or $10. Thus, in this setting the joint hypothesis problem is mitigated.
By matching the time at which NFL scores occur with price movements of Tradesports NFL contracts, I have come across an unusual trend (PDF) – selling contracts during active events is profitable, and even more so when the transaction is executed right after a touchdown occurs.
Why?
The structure of Tradesports assets is such that an understanding of short selling is required to make an informed trading decision. On this exchange, when Team A plays against Team B, the contract is framed relative to Team A. That is, a trader must either buy a bet on Team A or else sell a bet on Team A. This is not the case in traditional casino-style markets, where one can buy a bet on Team A or else buy a bet on Team B.
If I were to propose that NFL bettors are generally less sophisticated than equity traders, there would be few objections. Short selling is a procedure with which few NFL bettors are familiar. This deficiency causes a reluctance to sell, creates a supply shortage of bets on Team A, and produces an unwarranted price increase of bets on Team A. The end result is that NFL contracts expire at $0 more often than expected, and the sellers cash in.
