Can I hedge real-world risk using prediction markets?

Detailed Explanation

1. What hedging means: You accept a smaller certain cost (hedge premium) to reduce downside if an adverse event occurs.
2. Match the exposure: The contract must reflect the same event driver as your business/portfolio risk.
3. Basis risk: Your loss may not perfectly align with contract payout (mismatch in timing, definition, magnitude).
4. Why it exists: Markets provide a clean “event insurance” instrument when options/futures aren’t available.

Common Scenarios

• Company revenue sensitive to a regulatory approval
• Portfolio sensitive to a central bank decision
• Supply chain risk tied to a geopolitical event
• Marketing spend tied to a major sports outcome

Exceptions & Edge Cases

• If the contract resolves on an indicator that’s correlated but not causal, then hedge may fail when you need it.
• If you can’t size the hedge adequately due to liquidity/limits, then protection is partial.
• If settlement timing is slow, then hedge may not pay when cash is needed.

Practical Examples

• You fear a “No approval by June 30” outcome could cost you $200k.
  • “No” shares are $0.30
  • You buy 5,000 shares → potential payout $5,000 if “No”
  • That’s a small hedge unless you can scale; illustrates sizing constraints.

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

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