A recent scandal involving a Green Beret arrested for betting on a classified U.S. raid has brought attention to the inner workings of prediction markets. A new study suggests that this incident may be more than just an isolated case, as it points to a larger issue of informed traders influencing market prices. The study, conducted by researchers from London Business School and Yale, analyzed over 1.7 million accounts and $13.7 billion in trading volume on Polymarket, finding that a mere 3% of traders are responsible for the majority of price movements.
These informed traders consistently predict outcomes and drive prices in the right direction, while the remaining 97% of traders largely provide liquidity and generate volume, but ultimately end up on the losing side of trades. The researchers used a novel approach to distinguish between skilled traders and those who are simply lucky, rerunning each trader's bets 10,000 times with the direction of the trade randomly flipped. The results showed that only 12% of the biggest winners by raw profit were able to consistently outperform the random benchmark, and many apparent winners were found to be lucky rather than skilled. The study's findings have significant implications for our understanding of how prediction markets work, suggesting that it is the informed minority rather than the crowd that drives market accuracy.
The researchers found that when skilled traders account for a larger share of trading, prices move closer to the correct outcome, especially in the final stages before resolution. However, the study also raises important questions about the role of non-public information in prediction markets, and the potential risks of insider trading.
The researchers highlight a concrete example of this risk, in which three newly created accounts on Polymarket placed large bets on a contract related to the removal of Nicolás Maduro from power in Venezuela, just before the operation took place. While there is no evidence of wrongdoing in this case, the incident underscores the need for greater transparency and oversight in prediction markets.