Research Reveals That Only a Small Percentage of Informed Traders Drive the Accuracy of Prediction Markets

A recent scandal involving a Green Beret betting on a classified US raid may be more than an isolated incident, as a new study suggests that a small group of informed traders, like the soldier in question, have a disproportionate influence on the accuracy of 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, and found that just 3% of traders are responsible for most of the price discovery, meaning they drive prices towards the correct outcome. These traders consistently make accurate predictions and move prices in the right direction, while the remaining 97% of traders provide liquidity and generate volume, but ultimately end up on the losing side of trades. The researchers used a novel approach to distinguish between skill and luck, rerunning each trader's bets 10,000 times with the direction of the bet randomized, to filter out traders who were simply lucky. The findings show that among the biggest winners, only 12% consistently outperformed the benchmark, and many apparent winners did not sustain their performance over time. The activity of skilled traders improves market accuracy, particularly in the final stretch before resolution, and they are also 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 a concrete example of three newly created Polymarket accounts that placed large bets on a contract related to the US removal of Nicolás Maduro from power in Venezuela, just before the operation. 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 presence of a small group of informed traders.