Comment Text:
I believe prediction markets, including predicting elections, should be legal and regulated in the United States. Prediction markets are a very effective tool, besides pooling, for predicting future events. However, prediction markets should not be seen as a check or validation of our elections as some other commentators have pointed out. We should trust our elections independent of what prediction markets are indicating.
I would like to point out the idea of needing this particular exchange for the sole purpose of hedging an outcome is an overreach. Let's look at a real hedging scenario; I believe company X will outperform company Y in the short term and company X and Y have the same industry and market exposure. I will long company X using $1000 and short company Y using another $1000. That way, my total exposure to the market, industry, and USD currency is all zero. This should be a perfect hedge meaning my gain or loss is only dependent on if X outperforms Y or not. This perfect hedge also ensures that it is extremely unlikely that I will lose my initial $2000, a property of a well-constructed hedging instrument which minimizes my industry, market, and currency exposures.
Now let us take an example from Kalshi posted; "I am an individual. A few years ago, I went to college but ended up dropping out. Recently passed policies by the current Congress, such as making community college free for people under a certain income threshold and favorable interest-rate policies for student borrowers. I ended up going to college again because of these new policies. If the opposing party comes to power and undoes these new policies, I may not have gone to college in the first place. It would substantially increase the cost of my education and make me rethink the entire effort, possibly saddling me with debt for a degree I don’t want anymore. I would buy Yes that that party would win the midterms, letting me at least give me something to cushion myself against those policy changes."
Let us throw some numbers into this; say I am the student and if the unfavorable party is elected, I MIGHT need an additional $10,000 to cover my tuition. So how much should I buy to hedge? Well, that depends on the current price of the Yes contract. If the contract is at $50c (equal probability of any party winning) then I will need to buy $10,000 of Yes to cover the $10,000 that I believe I MIGHT need in the future. If the contract is at $10c (unlikely the unfavorable party would win) then I need to buy $1111 of Yes to cover the $10,000 that I believe I MIGHT need in the future. If the contract is at $90c (likely the unfavorable party would win) then I need to buy $90,000 of Yes to cover the $10,000 that I believe I MIGHT need in the future.
What this shows is that even at a low probability of an unfavorable event occurring such as 10%, I am risking $1,111 of money I have right now in my pocket to cover the additional tuition that I MIGHT need in the future. This doesn't even include the fees that I have to pay beforehand. In addition, I keep using the terms "I MIGHT" because the event that the unfavorable party gets elected does not imply that they will with 100% probability overrule the existing policy. So, this election contract is not even a perfect hedge, meaning the event I am worried about isn't guaranteed to be covered by this contract. In all fairness, this election contract example, and others from Kalshi, do not behave or have the properties of a well-constructed hedging instrument because the risks are variable depending on the market price and the underlying exposures are unknown.
Consider having Kalshi walk through a real-world example, using numbers, to see just how they think their markets can be used to hedge an event.
In conclusion, I would love to see prediction markets such as Kalshi and others operating in the United States. However, I will not, and I recommend others as well, not use prediction markets to create a hedging instrument because their underlying exposures are simply unknown and variable.
