Prediction Market
Also known as: Event contract, Event derivative
A contract paying $1 if an event happens and nothing otherwise, so its price reads as a probability. A forecasting instrument that is also, unavoidably, a wagering one.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat is it, really?
A prediction market sells contracts on whether something will happen. Each one pays $1 if the event happens and nothing if it does not. Because the payoff never changes, the price says something plain: a contract trading at 63 cents means the market thinks there is roughly a 63% chance.
It is the same instrument as a binary option. Two differences matter.
- Other traders set the price, by posting bids and offers. Nobody is quoting you a price while taking the opposite side of your bet.
- The thing being bet on is an event — an election, an inflation figure, a court ruling — rather than the price of something.
The interesting claim here is not that individual traders are good at forecasting. It is that a market pulls together what a lot of people each know a little of, and makes them put money behind it, which strips out the cheap talk. Whether that beats the alternatives is a question for evidence rather than argument, and the evidence is genuinely mixed.
Point at a line to pick it out from the others.
- Asset class
- Alternatives (event-linked)
- Instrument type
- Binary event contract
- Traded
- Regulated exchanges in some jurisdictions; offshore elsewhere
- Typical users
- Forecasters, hedgers of event risk, speculators
Which risks decide the outcome
Not how risky this is, and not a rating — there is deliberately no total. It says which of five failure modes drives what happens here, in the same order on all 129 products so they can be compared. This publication's own reading; see the notice below.
- Marketdecides it
- Creditbarely applies
- Liquiditymatters
- Fundingbarely applies
- Operationaldecides it
What decides it here. The payoff is decided by a resolution rule, so an ambiguous real-world outcome becomes an argument about wording rather than about price.
3 · IntermediateHow it works in practice
Where the price stops being a clean probability
- The longshot bias. Contracts at very low prices trade persistently above their realised frequency. A 3% contract has historically resolved yes less often than 3% of the time — the same bias documented for decades in betting markets, and it survives in prediction markets too.
- The cost of capital. Buying a contract at 0.95 to make 0.05 ties up capital until resolution. Over six months that is an unattractive annualised return, so nobody arbitrages the last few cents — which is exactly why extreme prices are least reliable.
- Fees and spreads sit inside the price. A market quoted 0.62/0.65 has no single probability, and the mid is a convenience.
- Thin markets are opinion, not aggregation. A contract with little volume reflects whoever showed up, and the informational claim rests entirely on depth.
Genuine hedging uses
| Exposure | Event contract as a hedge |
|---|---|
| A regulated firm facing a rule change | Buy the contract on the rule passing |
| A farmer facing weather | Overlaps with weather derivatives, at retail size |
| A business exposed to a policy outcome | Cheaper than restructuring operations in advance |
These are real, and they are also the argument regulators have found least persuasive — because the same contract serves a hedger and a gambler identically, and the venue cannot tell them apart.
4 · AdvancedPricing & valuation
The evidence on accuracy, honestly summarised
- Prediction markets have generally matched or modestly beaten polling averages for election outcomes, and have done well on binary, well-defined, near-dated questions with liquid markets.
- They have done poorly on long-dated questions, on questions with ambiguous resolution criteria, and at extreme probabilities.
- They are not magic aggregators: they reflect the beliefs of the people trading them, weighted by capital. A market dominated by one demographic prices that demographic's beliefs, and the money-weighting is a feature only if the informed are also the well-capitalised.
- The most robust finding is comparative rather than absolute: a market price is a hard-to-beat baseline, and beating it consistently requires genuine private information — the same standard as any other market.
The regulatory position is the product's main risk
Jurisdictions differ sharply, and the differences are not stable:
- Some regulators have authorised event contracts on designated exchanges with position limits and defined categories.
- Others treat them as gambling, subject to entirely separate licensing, or prohibit them outright.
- Contracts on elections have been the most contested category, litigated in several jurisdictions with outcomes that have shifted more than once.
- Offshore and crypto-settled venues operate outside all of this, and carry counterparty and settlement risks that no regulated exchange would permit — the custody question, again.
Resolution risk is the underrated one
Every contract depends on an agreed source declaring the outcome. Ambiguous wording, a delayed source, a revised statistic or a disputed result creates genuine settlement risk on a contract whose whole appeal is that the payoff is unambiguous. Serious venues publish detailed resolution criteria for exactly this reason, and reading them is the diligence — the payoff structure has no subtlety, and the definition has all of it.
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.
5 · Desk notesHow practitioners think about it
Now say it back
Close the page and give Prediction Market in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.
- Who wants what — two parties wanted opposite things badly enough to write it down.
- What the contract obliges, and when — not the payoff; the obligation.
- Where the money comes from — name the source, or you have described a hope.
- What makes it lose — the ordinary way, not the dramatic one.