The Role of Speculative Trade in Market Efficiency: Evidence from a Betting Exchange

Does speculative trade reduce mispricing - and help create efficient markets - or drive prices further from fundamentals? We analyse betting exchange trading, on 9,562 U.K. horse races in 2013 and 2014, to find out. Crucially, as each race is run, the fundamental value of bets is unambiguously revealed. We find that the direction and volume of market order trade is predictive of fundamentals, suggesting that speculative trade is, on average, conducive to market efficiency. However, much of this effect is concentrated in the in-running period (during races) - when, even without trade, asset fundamentals would be revealed seconds later.