Update: edited numbers, earlier one was incorrect.
IMO in real world examples (not meme examples like this religious one) tail risk will often dominate the price calculation, not time value. Time value seems relevant here only because the tail risk is zero. (Both buyer and seller agree that probability of yes on this market is zero)
Let’s say actual probability of some event is 3% yes and both parties agree on this. It still could be rational for a larger investor to buy no and a small investor to buy yes at 3.5% for example. Insurance market is analogous to this, it is possible for both the insurance buyer and seller to be rational at the same time because there is transfer of tail risk. The only person who can rationally accept a 3.5% chance of a $1B portfolio going to zero is someone who owns over $10B. (Assuming a utility function that makes sense for a human being) So it’s the largest investors and ultimately federal banks who absorb most of the tail risk of society.
Also ofcourse not everyone is rational when it comes to avoiding taking on tail risk, 2008 financial crisis is an example of this. Beyond a point if federal banks can’t absorb the tail risk they diffuse the losses to everyone.
I’m guessing the actual reason you’re interested in this is because you want prediction markets on existential questions, and there too the actual question is who absorbs the tail risk of society on behalf of everyone else.
P.S. In markets that are not low probability, variance of asset price (not just time value) will matter when constructing optimal portfolio. So sharpe ratio is a better metric to study than expected value. In general I guess people without financial background are not used to thinking about variance risk and tail risk.
Update: edited numbers, earlier one was incorrect.
IMO in real world examples (not meme examples like this religious one) tail risk will often dominate the price calculation, not time value. Time value seems relevant here only because the tail risk is zero. (Both buyer and seller agree that probability of yes on this market is zero)
Let’s say actual probability of some event is 3% yes and both parties agree on this. It still could be rational for a larger investor to buy no and a small investor to buy yes at 3.5% for example. Insurance market is analogous to this, it is possible for both the insurance buyer and seller to be rational at the same time because there is transfer of tail risk. The only person who can rationally accept a 3.5% chance of a $1B portfolio going to zero is someone who owns over $10B. (Assuming a utility function that makes sense for a human being) So it’s the largest investors and ultimately federal banks who absorb most of the tail risk of society.
Also ofcourse not everyone is rational when it comes to avoiding taking on tail risk, 2008 financial crisis is an example of this. Beyond a point if federal banks can’t absorb the tail risk they diffuse the losses to everyone.
I’m guessing the actual reason you’re interested in this is because you want prediction markets on existential questions, and there too the actual question is who absorbs the tail risk of society on behalf of everyone else.
P.S. In markets that are not low probability, variance of asset price (not just time value) will matter when constructing optimal portfolio. So sharpe ratio is a better metric to study than expected value. In general I guess people without financial background are not used to thinking about variance risk and tail risk.