Noname manuscript No. (will be inserted by the editor) Market Manipulation with Outside Incentives

Abstract Much evidence has shown that prediction markets can effectively aggregate dis-persed information about uncertain future events and produce remarkably accurate forecasts. However, if the market prediction will be used for decision making, a strategic participant with a vested interest in the decision outcome may manipulate the market prediction to in-fluence the resulting decision. The presence of such incentives outside of the market would seem to damage the market’s ability to aggregate information because of the potential dis-trust among market participants. While this is true under some conditions, we show that, if the existence of such incentives is certain and common knowledge, in many cases, there exist separating equilibria where each participant changes the market probability to different val-ues given different private signals and information is fully aggregated in the market. At each separating equilibrium, the participant with outside incentives makes a costly move to gain trust from other participants. While there also exist pooling equilibria where a participant changes the market probability to the same value given different private signals and informa-tion loss occurs, we give evidence suggesting that two separating equilibria are more natural and desirable than many other equilibria of this game by considering domination-based be-lief refinement, social welfare, and the expected payoff of either participant in the game. When the existence of outside incentives is uncertain, however, trust cannot be establishe