A recent scandal involving a Green Beret arrested for wagering on a classified U.S. raid may be more than an isolated incident, as a new study suggests that such cases could be symptomatic of a broader issue - the influence of a small group of informed traders 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, revealing that a mere 3% of traders are responsible for the majority of price discovery, consistently predicting outcomes and driving prices towards the correct result. In contrast, the remaining 97% of traders primarily provide liquidity and generate volume, but ultimately end up on the losing side of trades against the informed minority. The researchers employed a novel approach to distinguish between skill and luck, rerunning each trader's bets 10,000 times with a coin flip determining the direction of the trade. The results showed that among the biggest winners, only 12% demonstrated skill, while many apparent winners were found to be lucky, with roughly 60% becoming losers when their performance was evaluated against a separate sample of events.
The study's findings indicate that the activity of skilled traders enhances market accuracy, particularly in the final stages before resolution, and that they are the first to respond to new information, such as Federal Reserve announcements or corporate earnings. However, the same edge that makes skilled traders valuable to price discovery also raises concerns when that information is not public or is not supposed to be.
The paper highlights the risk of insider trading, citing the example of the U.S. removal of Nicolás Maduro from power in Venezuela, where three newly created Polymarket accounts placed unusually large bets on the contract before the event, collectively making over $630,000. While insider trades are rare and concentrated in a handful of events, the study's findings challenge the notion that prediction markets work due to the collective wisdom of the crowd, instead suggesting that they are driven by the knowledge and actions of a small group of informed traders.