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Retail traders are beating big firms in -2-

Prediction markets have been around in one form or another for more than 500 years, beginning with wagers on papal elections in the 1500s. The earliest form of prediction markets on Wall Street took shape around 1884, with betting on the outcome of presidential elections, according to authors Paul Rhode and Koleman Strumpf. In more recent decades, these markets have occasionally been confronted with ethical dilemmas over the propriety of betting on geopolitical outcomes, and described by some critics as "terrorism betting parlors." Congressional criticism, for example, led to the shutdown of a prediction market created by an arm of the U.S. Defense Department in the early 2000s.Despite the naysayers, experts said prediction markets can play a vital role in society, are reasonably efficient, and tend to perform well - despite occasionally being limited by low liquidity. Eric Zitzewitz, an economics professor at Dartmouth College, said "these markets are better at getting liquidity on topics that people find interesting or enjoy betting on...What's surprising, though, is how accurate the answers can be that come out of occasionally illiquid markets." The ability to forecast the most likely direction of interest rates, for example, can help businesses and consumers anticipate when and by how much they should be spending and investing.

How to play

Traders on Kalshi usually give a yes-or-no answer to an array of questions that have related contracts. Those contracts eventually settle at either $1 if a certain event happens and zero if it does not, with odds expressed in terms of cents before they happen. Traders can buy or sell these contracts at any price between zero and $1 before the event. As of Wednesday, the question of how many times the Fed will reduce rates this year was trading at 32% odds, or 32 cents, of just one rate cut. This is the scenario with the highest probability.

'What's surprising, though, is how accurate the answers can be that come out of occasionally illiquid markets.' Eric Zitzewitz, economics professor at Dartmouth College

The performance of retail investors versus fed funds futures traders is similar to other little-guys-versus-big-guys patterns seen over the past few decades, including the time Wall Street Journal readers outperformed four investment professionals by losing less when it came to picking stocks during the early 2000s.

In 2021 and 2022, Robbins, the part-time Kalshi trader, remembers thinking how "crazy" it was that financial markets were "pricing in so little tightening, when during that time I thought the Fed would need to be tightening more." The Fed "was providing a narrative that a lot of this inflation was transitory, but you could look at how broad-based it was and see that wasn't the case," he added.Fast forward to late 2023 and early this year, and the storyline "flipped" in Robbins' mind - with fed-funds futures traders anticipating multiple quarter-point Fed rate cuts. Robbins said he recalls thinking "that was outlandish, given inflation was consistently higher than the Fed's target and won't go down nearly as fast as the market thinks."

-Vivien Lou Chen

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05-15-24 1303ET

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