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

Martin Strobel, University of MaastrichtDIMACS, Feb Prediction Markets: General Idea Reality Market PricePrediction Action Mani- pulator

Martin Strobel, University of MaastrichtDIMACS, Feb 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 …

Martin Strobel, University of MaastrichtDIMACS, Feb 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

Martin Strobel, University of MaastrichtDIMACS, Feb Experimental Design: Manipulation I Robot player for manipulation Focus on one simple method: excessive buying leads to price increases 90 sec quiet 240 sec manipulation 90 sec “recovery” (60 sec) Lowest ask Highest bid Asks Bids Lowest ask+10 Random bid was placed

Martin Strobel, University of MaastrichtDIMACS, Feb 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) Lowest ask Highest bid Asks Bids Lowest ask+10 Random bid was placed

Martin Strobel, University of MaastrichtDIMACS, Feb Experiment Design: Software

Martin Strobel, University of MaastrichtDIMACS, Feb Expectations 100 price fund. value best case baseline case manipulation case

Martin Strobel, University of MaastrichtDIMACS, Feb Analysis start of market start of manipulation end of market end of manipulation 90 sec 270 sec60 sec 420 sec BeforePrice AfterPrice EndPrice Manipulation has no effect Manipulation has a temporary effect Manipulation has a durable effect Hypotheses:

Martin Strobel, University of MaastrichtDIMACS, Feb Results CoefficientsBeforePriceAfterPriceEndPrice Fund. value 0.36** [0.19; 0.53] 0.52*** [0.32; 0.73] 0.67*** [0.57; 0.77] Directly manip [-10.10; 9.74] 3.83 [-3.00; 10.66] 3.25** [0.47; 6.04] Indirectly manip [-8.73; 6.41] [-6.90; 5.33] -3.11*** [-4.84; -1.39] Constant 30.84** [16.05; 45.62] 22.04*** [8.42; 35.66] 16.57*** [11.92; 21.22] R2R Observations

Martin Strobel, University of MaastrichtDIMACS, Feb 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!?

Martin Strobel, University of MaastrichtDIMACS, Feb Further Plans Varying knowledge, uncertainty, discreteness, … Allow for short-selling? Compare results to Hanson, Oprea and Porter (forthcoming)