Abstract
The Marginal Trader Hypothesis (Forsythe et al. 1992, in American Economic Review 82(5): 1142–1161) posits that a small group of well-informed traders keep an asset’s market price equal to its fundamental value. Forsythe et al. base this claim on evidence from U.S. presidential prediction markets. We test the Marginal Trader Hypothesis by examining a decision task that precludes marginal traders. Specifically, students are asked to predict the class average for a given exam. We show that performance on our task is similar to that reported for the Iowa Electronic Markets, and that accuracy is unrelated to academic performance and does not correlate across tasks.
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Notes
We should note that Camerer et al. (1989) may not agree with our conclusions. In their paper they go on to show that less biased traders are able to self-identify in that they correctly predict they will make more accurate predictions than other subjects and they correctly predict that they will make higher earnings than other subjects. In addition, these less biased traders are more aggressive in the asset markets, and make more trades. These less biased traders share important characteristics with marginal traders — they have better “judgment” and they make more trades.
We are not convinced that Camerer et al. prove that less-biased traders know of their relative proficiency and use that information to increase their earnings. Our reasoning is as follows: the subjects were asked for their measures of relative performance after the experiment had ended, and at that point successful traders could self-identify. Although the subjects could not know their relative performance perfectly (that information was not given to them), they could deduce their relative performance imperfectly by recalling the asset market activity. That is, a particular subject might know that he sold an asset for a profit, and in this market that would imply the buyer lost money (every trade is zero sum in this market). So if a subject profited on a number of trades, he would know that he had performed relatively well in the experiment. This subject could then use this information to more accurately predict his relative performance.
We examined some other measures, such as mean squared error, and find results that are consistent with those presented here.
The results are unaffected qualitatively by assuming equal variances.
For example, the results of the prediction market for the 2008 US Presidential Election would be included because the actual value for both of the available futures contracts, the share of the popular vote for Obama and McCain, respectively, were greater than 20%.
Note this observation is similar to Malkiel’s (2003) conclusion that almost all mutual fund managers fail to reproduce excessive gains from year to year.
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Blackwell, C., Pickford, R. The wisdom of the few or the wisdom of the many? An indirect test of the marginal trader hypothesis. J Econ Finan 35, 164–180 (2011). https://doi.org/10.1007/s12197-009-9092-4
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DOI: https://doi.org/10.1007/s12197-009-9092-4