MARKET INFORMATION FROM PREDICTION MARKET AND ITS POTENTIAL AS A FINANCIAL INSTRUMENT

Abstract

Prediction markets have grown rapidly as platforms for aggregating beliefs about future events, yet their role as financial instruments remains not well understood, particularly relative to traditional markets. This is especially relevant for macroeconomic outcomes such as Federal Reserve interest rate decisions and gold prices, where parallel expectation measures already exist in established financial instruments. This paper studies prediction markets as state-contingent financial assets and evaluates their behavior alongside traditional benchmarks. Using data from Polymarket, CME FedWatch, U.S. Treasury bills, rate-sensitive indices, and gold futures, the analysis compares belief dynamics through time-series methods and examines their economic relevance through portfolio construction. Prediction market positions are incorporated as overlays within traditional portfolios to assess their impact on risk and return characteristics, with additional analysis of how contract structure, such as discretized outcome bins, influences pricing and information representation. The results show that prediction markets are becoming increasingly aligned with market-implied probabilities, particularly for central outcomes, while exhibiting meaningful variation across event windows that reflects evolving macroeconomic conditions. They exhibit varying volatility, VaR, ES, and other financial characteristics, making them a plausible candidate for hedging. Portfolio experiments indicate that overlays concentrated in high-probability outcomes can improve risk-adjusted performance, whereas tail-outcome positions tend to underperform due to their binary payoff structure. Despite their simplicity, these portfolio constructions demonstrate that prediction market signals can contribute to diversification. Overall, prediction markets aggregate economically relevant information and offer a distinct signal complementary to traditional instruments, though their effectiveness remains dynamic and dependent on market structure and external conditions.