Prediction Markets for Hedging

You’ve been talking about prediction markets as tools for hedging, not just trading. Can you explain that? This is something I want to use Cheap Convexity to really hammer on. Right now, the only businesses that hedge energy prices are large corporations: airlines, energy companies. A small manufacturer with real exposure to oil prices has no practical way to hedge a tail scenario.

But functionally, a prediction market event contract is just an option on an event or a price level. If you’re a small business that gets badly hurt if oil goes to $120 but doesn’t really care whether it’s at $60 or $80, you can buy a contract that pays out at $120 for, say, a 5-7% premium. That’s exactly what Goldman Sachs would structure for a Fortune 500 client, just with more zeros. You don’t need to pay for markets to chop around in their normal range. You only want exposure at the tail, because that’s where you actually get hurt.

The same logic applies to currencies. I live in Israel and earn dollars. Dollar-shekel has moved about 20% in two years. That’s a meaningful change in my cost of living. I would pay a small premium to own the tail of that. Every real business has currency risk, interest rate risk, energy risk. None of them are solving for it at the small business level. Prediction markets are the obvious answer.