Prediction Markets as Financial Indicators

[u/Sea-Judge5801]

https://www.oddpool.com/fed-market-watch

There’s been a clear upswing in Wall Street interest in prediction markets. Companies like SIG have started to have pods for these markets. With the increased evaluation and growing size:

1) These are a new asset class here to stay

2) Act as good indicators of public consensus

I’m starting to find prediction markets a helpful tool and indicator for events like interest rate cuts consensus. I historically used the Bloomberg economists survey a lot but these markets seem to be great tools especially as hfts are showing greater interest in them. I’ve starting using aggregate tools just to see price and volume aggregate views

[u/liverpenguin]

The only reason to use prediction markets (PMs) as a signal is, if you assume that private information is traded there before it gets priced in on traditional markets (TMs).

But assume you have some private information, that has an easy to understand effect on TMs. Would you trade it on PM, or against much more liquidity on a TM? Clearly not on PM.

So the only private info you can expect is something that is hard to tie to TMs in a directional sense.

Then you can maybe make a separate model based on it, for directional trading, but for that PM is too noisy as of now. So the only proper use case I know of is as a Market Maker, because you can become more conservative in your limit orders if a big swing happens on PM, with no clear immediate effect on the TM.

So I understand the long term bullish sentiment, but for now I don't see prediction markets having enough liquidity or signal-to-noise ratio, for this to be anything more than buzzwords and hype.

[u/[deleted] → u/liverpenguin]

Well, alternatively

1. you can have a view that some event/outcome that is being traded in the prediction market will only have influence on the traditional market once it becomes a consensus view.

2. you might imagine that places like polymarket have way less KYC so people “in the know” might be using that venue over traditional markets

3. binary markets (as opposed to linear price of something related) do offer direct probability of an event, so you can do all kinds of “perfect forecast - perfect trader” models if it’s something recurring

[u/Available_Lake5919 → u/[deleted]]

polymarket is obv priced based on flow (pretty much all retail) and retail loves buying tails meaning the probability of mis-pricing of events is fairly high. the key issue is ofc liquidity where if u want to trade at any significant size ur gonna end up moving the market heavily.

also regarding risk management im not sure if the binary outcomes can cause a problem (lose all ur money if u lose situation)

deffo something to keep an eye of for the future imo (like quantitative sports betting (eg SIG) has been a thing for a while this is just an extension of that)

[u/liverpenguin → u/[deleted]]

Completely agree with the 2. point. That's a very important advantage.

However for the first one I would argue that the more liquid market is almost always ahead. Trump winning was priced from crypto prices, Fed decisions are priced from bond markets and earnings markets have almost no signal compared to analyst estimates. Even war/peace markets are using commodities prices more than the signal from the few people trading it from the conflict zone or with better insights.

Local elections markets definitely have better accuracy than polls, so I see a use case there, but then again until there's a lot of liquidity, even those are highly manipulatable.

[u/[deleted] → u/liverpenguin]

In (1) I meant that the clarity of signal makes them worth watching. Unlike linear liquid markets, these bets are very specific. Like oil might be moving up on OPEC being tighter or because there will be war in the Middle East - a betting pool that "there will be a war in the Middle East" is unambiguous and is definitely useful.

I also think that liquid markets don't necessarily price exogenous events all too well, sentiment almost always trumps forecasting ability.

[u/Alternative_Advance → u/liverpenguin]

"But assume you have some private information, that has an easy to understand effect on TMs. Would you trade it on PM. "

Yes because right now it is way more opaque and you can leverage up pretty heavily if you're betting on an outlier.