Relatedly, I thought that the fair market price of a contract which pays out $1 if Trump gets elected is just the probability of Trump getting elected. This is wrong because Trump getting elected is correlated with how valuable other assets are. Suppose I thought that Trump has a 50% chance of getting reelected, and if he gets re-elected, the stock market will crash. If I have a bunch of my money in the stock market, the contract is worth more than 50 cents, because it hedges against Trump winning.
Isn’t this effect going to be very small for almost all markets, and still fairly moderate for presidential ones?
Not that you talked about effect size either way, I’m just wondering how much I should adjust predictions from markets for this reason.
I think it would be extremely material for the 2020 Presidential Election. Lets say for sake of argument that Biden winning means the TCJA gets partially reversed and corporate tax rates go up 2%. That would have an extremely large (downward) impact on stock prices.
The market cap for stocks is huge O(10^13) compared to amounts wagered on the Presidential Election O(10^8), so any effect is going to swamp prediction markets.
However, I don’t believe that this effect is material to prediction markets at the moment.
1/ Prediction markets just aren’t super efficient. Compare PredictIt (41%), Betfair (36%) and various other venues to see the kind of differences out there in estimates for the odds of Trump winning re-election.
2/ Volumes aren’t super high, so this sort of hedging the author talks about is a long time away.
3/ Financial actors have much more liquid ways of hedging election risk than hedging in thin prediction markets.
Isn’t this effect going to be very small for almost all markets, and still fairly moderate for presidential ones?
Not that you talked about effect size either way, I’m just wondering how much I should adjust predictions from markets for this reason.
I think it would be extremely material for the 2020 Presidential Election. Lets say for sake of argument that Biden winning means the TCJA gets partially reversed and corporate tax rates go up 2%. That would have an extremely large (downward) impact on stock prices.
The market cap for stocks is huge O(10^13) compared to amounts wagered on the Presidential Election O(10^8), so any effect is going to swamp prediction markets.
However, I don’t believe that this effect is material to prediction markets at the moment.
1/ Prediction markets just aren’t super efficient. Compare PredictIt (41%), Betfair (36%) and various other venues to see the kind of differences out there in estimates for the odds of Trump winning re-election.
2/ Volumes aren’t super high, so this sort of hedging the author talks about is a long time away.
3/ Financial actors have much more liquid ways of hedging election risk than hedging in thin prediction markets.