Why do prediction markets sometimes disagree with financial markets?

Prediction markets and financial markets price different things: discrete outcomes versus continuous economic impact. Disagreement often reflects different assumptions, time horizons, or risk premia.

Detailed Explanation

Different pricing objectives:

• Prediction markets price the probability of a discrete event (Yes/No)
• Financial markets price expected value of continuous cash flows or assets

Time horizon mismatch:

• Stock prices reflect long-term discounted earnings
• Prediction markets often focus on near-term binary outcomes

Risk premia differences:

• Financial markets embed risk premia for volatility, liquidity, and correlation
• Prediction markets are more purely probabilistic (though still affected by participant risk aversion)

Information asymmetry:

• Different participant bases with different information sets
• Prediction markets may attract specialists in specific event types

Common Scenarios

• Stock drops 10% but prediction market shows only 5% probability of bankruptcy
• Election prediction market at 70% for Candidate A while equity markets seem to price in Candidate B winning
• Fed funds futures imply rate cut but prediction market shows lower probability
• Currency moves suggest geopolitical tension but prediction market on conflict stays flat

Exceptions & Edge Cases

• If markets are pricing the same event with identical definitions, then divergence may signal arbitrage opportunity.
• If prediction market liquidity is thin, then financial market prices are likely more reliable.
• If the event has asymmetric payoffs in financial markets, then divergence is expected, not anomalous.

Practical Examples

Event: "Regulatory approval of Drug X"

• Prediction market: 45% probability of approval
• Stock price: Already discounting 60% chance (based on expected value analysis)
• Explanation: Stock embeds approval impact + other company factors; prediction market is pure probability

Event: "Trade deal signed by year-end"

• Prediction market: 30% probability
• Equity sector: Trading as if deal is 50% likely
• Explanation: Equities also price in partial deals, extensions, and other positive catalysts

Actionable Takeaways

• ✅ Avoid assuming one market is "wrong"
• ✅ Use divergence as a research prompt
• ✅ Separate likelihood from impact
• ✅ Identify what each market is actually pricing