Towards a methodology for measuring the true degree of efficiency in a speculative market

Betting markets have drawn much attention in the economics, finance and operational research literaturebecause they provide a valuable window on the manner in which individuals use information in widerfinancial markets. One question that has received particular attention is to what extent individualsdiscount information in market prices. The predominant approach to explore this issue involvespredictive modeling to forecast market outcomes and examining empirically whether abnormal returnscan be made by employing these forecasts. It is argued here that present practices to assess suchforecasting models, including the use of point estimates and information, which would not be availablein practice (at the forecasting stage) and failing to update forecasting models with information from therecent past, may give rise to misleading conclusions regarding a market’s informational efficiency.Hypotheses are developed to conceptualize these views and are tested by means of extensive empiricalexperimentation using real-world data from the Hong Kong horserace betting market. Our studyidentifies several sources of bias and confirms that current practices may not be relied upon. A moreappropriate modeling procedure for assessing the true degree of market efficiency is then proposed