A recent scandal involving a Green Beret accused of betting on a classified US raid may be more than an isolated incident, as a new study suggests that informed traders like him play a significant role in shaping prices on prediction markets. The study, conducted by researchers from London Business School and Yale, analyzed over 1.72 million accounts and $13.76 billion in trading volume on Polymarket, finding that just 3% of traders are responsible for most price discovery. These traders consistently demonstrate an ability to predict outcomes and move prices in the right direction, while the remaining 97% largely provide liquidity and generate volume, but ultimately end up on the losing side of trades. To distinguish between skill and luck, the researchers simulated each trader's bets 10,000 times, finding that only 12% of the biggest winners consistently outperformed the benchmark.
The study's findings have significant implications for our understanding of prediction markets, suggesting that it is the informed minority, rather than the crowd, that drives market accuracy. The activity of skilled traders improves market accuracy, particularly in the final stages before resolution, and they are often the first to react to new information. However, the same edge that makes skilled traders valuable to price discovery raises concerns when that information is not public or is not supposed to be. The study highlights the risk of insider trading, citing the example of the US removal of Nicolás Maduro from power in Venezuela, where three newly created accounts placed unusually large bets on the outcome before the event.
While insider trades are rare and concentrated in a handful of events, the study's findings challenge the idea that prediction markets work due to the collective knowledge of their participants, instead suggesting that they work because of the informed traders who drive price discovery.