Suckers are Born but Markets are Made: Individual Rationality, Arbitrage, and Market Efficiency on an Electronic Futures Market
Kenneth Oliven and Thomas A. Rietz
Management Science
Vol. 50, No. 3, March 2004, pp. 336�351
- Abstract
The Iowa Electronic Markets are specially designed futures markets that appear to aggregate information
efficiently to predict events such as election outcomes. Yet, in theory, perfect information aggregation is
impossible. Further, the markets are populated by a nonrepresentative sample of mistake-prone and biased
traders. That is, traders are prone to the behavioral anomalies predicted by behavioral finance. How can this be
reconciled with market efficiency? Here, we take a first step by analyzing the behavior of two self-selected types
of traders. Dramatic differences in mistake rates across traders can help us answer the question. Market-making
traders who set prices are less mistake prone and appear to be more rational than price-taking traders. This
highlights an important feature of markets: marginal (in this case, market making), not average, traders set
prices. This can drive the efficiency of market prices in spite of large numbers of traders who display patently
suboptimal behavior.
- Published Paper