Why do prediction markets sometimes disagree with financial markets?

Detailed Explanation

Prediction markets typically focus on whether a specific event occurs, while financial markets price the magnitude, timing, and second-order effects of many possible outcomes. A policy change may be considered likely in a prediction market but have limited expected economic impact, leading financial markets to react less—or differently. Conversely, financial markets may move aggressively on risks that prediction markets view as low probability but high impact. Divergence between the two often highlights uncertainty about transmission mechanisms rather than disagreement about facts.

Common Scenarios

• Central bank decisions vs equity reactions
• Election outcomes vs currency moves
• Regulatory approvals vs sector pricing
• Geopolitical risk vs commodity prices

Exceptions & Edge Cases

• If an event has binary payoff, then markets may converge.
• If financial markets hedge tail risk, then prices may overreact.
• If prediction markets are illiquid, then disagreement may be noise.

Practical Examples

• Market prices a rate cut at 70%, but equities barely move.
• Investors believe the cut is already priced into valuations.

Actionable Takeaways

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

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