Comment Text:
Please see the attached comment letter for a detailed empirical analysis of event contract pricing on prediction markets.
Drawing on 291,309 resolved contracts across six platforms including the CFTC-regulated DCM Kalshi, my research demonstrates that event contract prices are not pure objective probabilities but rather risk-adjusted derivative prices that embed a systematic, statistically significant pricing wedge (λ = 0.183, p < 10⁻¹⁵). This wedge arises from the structural incompleteness of event risk markets — event contracts are economically equivalent to binary options on non-tradable underlyings, and no-arbitrage arguments do not uniquely determine their prices.
Key findings relevant to the Commission's inquiries: (1) the favorite-longshot bias in prediction markets is an equilibrium consequence of incomplete-market pricing, not evidence of manipulation; (2) the pricing wedge reverses sign on play-money platforms, supporting a risk-compensation rather than cognitive-bias interpretation; (3) the wedge is time-varying, decaying as event uncertainty resolves; and (4) higher-liquidity markets exhibit smaller pricing distortions, suggesting that regulatory measures promoting liquidity would enhance price informativeness.
The full analysis, methodology, and policy recommendations are provided in the attached letter. The underlying research paper is available on SSRN (Abstract ID 6468338).
Respectfully submitted,
Yicheng Yang
University of Illinois at Urbana-Champaign
