Can I hedge real-world risk using prediction markets?

Yes—prediction markets can hedge exposure to discrete outcomes (policy changes, rate decisions, approvals, disruptions). The hedge works best when the contract outcome closely matches your real-world exposure and timing.

Detailed Explanation

1. Hedging logic: If a specific event hurts you in real life, you can profit from a prediction market position that pays when that event occurs, offsetting your loss.
2. Discrete vs. continuous: Prediction markets are best for discrete outcomes (yes/no, above/below). Continuous exposures (like stock prices) are harder to hedge perfectly.
3. Basis risk: If the contract doesn't exactly match your exposure (timing, definition, magnitude), you have residual risk.
4. Liquidity constraints: Large hedges may be impossible if the market is thin or has position limits.

Common Scenarios

• A business exposed to tariff risk buys "Yes" on tariff imposition markets
• An investor hedges rate-sensitive positions using Fed decision markets
• A company hedges regulatory approval risk for a competitor's product
• An exporter hedges currency policy by trading on central bank intervention markets

Exceptions & Edge Cases

• If the contract settles on a different date than your exposure, then you have timing mismatch risk.
• If the contract definition is narrow but your exposure is broad, then the hedge is imperfect.
• If you can't get enough size, then you're only partially hedged.
• If the market is illiquid at exit, then unwinding the hedge may be costly.

Practical Examples

You run a solar panel business that depends on a federal tax credit. Congress is voting next month.

• If the credit is repealed, your revenue drops 20%
• You buy "Yes" on "Tax credit repealed by [date]" at $0.30
• If repealed, you lose revenue but gain $0.70 per share in the market
• Size the hedge to match your expected loss (minus basis risk)

Actionable Takeaways

• ✅ Define the loss scenario and the event trigger
• ✅ Map your exposure to the contract's settlement definition
• ✅ Estimate basis risk (mismatch)
• ✅ Size with liquidity and limits in mind