Market manipulation with outside incentives

Much evidence has shown that prediction markets, when used in isolation, can effectively aggregate dispersed information about uncertain future events and produce remarkably accu-rate forecasts. However, if the market prediction will be used for decision making, a strategic participant with a vested in-terest in the decision outcome may want to manipulate the market prediction in order to influence the resulting deci-sion. The presence of such incentives outside of the market would seem to damage information aggregation because of the potential distrust among market participants. While this is true under some conditions, we find that, if the existence of such incentives is certain and common knowledge, then in many cases, there exists a separating equilibrium for the market where information is fully aggregated. This equilib-rium also maximizes social welfare for convex outside payoff functions. At this equilibrium, the participant with outside in-centives makes a costly move to gain the trust of other partic-ipants. When the existence of outside incentives is uncertain, however, trust cannot be established between players if the outside incentive is sufficiently large and we lose separability in equilibrium