Managing Financial Risk Via Prediction Markets

Abstract

This article examines the recent innovation of prediction markets, a new genre of financial markets, and how such markets can be utilized to assess, manage, and plan for risks of all types, including economic and financial risks. A comprehensive study of these markets concluded that prediction markets possess an “uncannily accurate” ability to predict future events in finance, business, politics, science, natural catastrophes, and virtually every other realm of human and natural activity. In finance, risks include recessions, stock-market crashes, stock-price collapses, interest-rate spikes, oil-price increases, adverse currency movements, and myriad other detrimental risks. As a risk assessment and risk-management tool, knowing the probability of an event happening in the future significantly facilitates the assessment and management of risks associated with that event.

TOPICS: Exchanges/markets/clearinghouses, analysis of individual factors/risk premia, VAR and use of alternative risk measures of trading risk