Abstract

Prediction markets are low volume speculative markets whose prices offer informative forecasts on particular policy topics. Observers worry that traders may attempt to mislead decision makers by manipulating prices. We adapt a Kyle-style market microstructure model to this case, adding a manipulator with an additional quadratic preference regarding the price. In this model, when other traders are uncertain about the manipulator’s target price, the mean target price has no effect on prices, and increases in the variance of the target price can increase average price accuracy, by increasing the returns to informed trading and thereby incentives for traders to become informed