Learn about Forecast Markets

Introduction to Forecast Markets

Forecast markets are platforms where people trade contracts based on their expectations of future events. By buying and selling these contracts, participants estimate the probabilities for given outcomes to occur, collectively harnessing the "wisdom of crowds." These markets show consensus opinions on various topics, from climate change to economic indicators. Unlike gambling, which often involves chance and entertainment, forecast markets focus on aggregating information and estimating probabilities, serving as tools for forecasting rather than mere speculation.

Contracts and Payouts

In forecast markets, participants buy "Yes" or "No" contracts tied to specific outcomes, such as an election result or an economic report. Each contract has a fixed payout: if the predicted event occurs, winning contracts pay a set amount (e.g., $1); losing contracts pay nothing. This simplicity makes event contracts accessible to a wide audience. Contracts are marked to market daily, meaning their value is adjusted to reflect the current market price.

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Trading and Liquidating Positions

On ForecastEx, trade occurs at any time the bid for a “Yes” and the “No” sums to $1.01, with the additional $0.01 serving as exchange fee. The exchange issues contracts to both sides at these prices. A contract holder can liquidate their position anytime by purchasing the opposite contract. If an account holds both a "Yes" and a "No" contract on the same event, the exchange pays out $1 per contract and cancels both positions. This mechanism allows traders to exit positions at any time prior to resolution.

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Mateo's First Forecast Market Trade

Mateo, a beginner investor curious about climate change, decides to try forecast markets. He finds a contract asking, "Will the average global temperature in 2025 be greater than 1.33 °C (2.39 °F) above the 20th-century average?" The "Yes" contract is trading at $0.40. Believing temperatures will rise, Mateo buys 1,000 "Yes" contracts at $0.40 each. If the event occurs, he’ll receive $1,000, making a profit of $600. If not, he loses his $400 investment, showing how contracts and payouts work.

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How can a trader liquidate their position in a forecast market before the event outcome is known?

A By holding the contract until maturity.

B By waiting for the exchange to automatically close the position.

C By transferring the contract to another trader without going through the exchange.

D By purchasing the opposite contract to cancel out their position.

A trader can liquidate their position by purchasing the opposite contract. If they hold both a "Yes" and a "No" contract on the same event, the exchange cancels both positions and pays out the fixed amount per contract.

Incentive Coupon Payments on Contracts

Some brokers pay incentive coupons on the daily value of open forecast market contracts, enhancing the appeal of participating. Incentive coupons are accrued each day and credited to the account monthly, providing returns even before the event outcome is known. This feature is especially beneficial for long-term contracts, as it compensates traders for tying up capital over extended periods. For instance, predicting the national debt in 2035 allows participants to earn incentive coupons while holding the contract.

Mateo Experiences Fluctuations and Incentive Coupon Payments

Time passes, and the price of Mateo's "Yes" contracts fluctuates with new climate data. When reports show rising temperatures, the price increases from $0.40 to $0.65, raising the value of his 1,000 contracts from $400 to $650. Conversely, cooling trends would drop the price to $0.30. Meanwhile, Mateo earns daily incentive coupons on the marked-to-market value of his contracts. For instance, at a 4% annual rate, a $650 value accrues $0.07 daily, credited monthly, adding $2.10 to his account for one month of holding.

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Market-Based Probability Estimation

The price of a contract in a forecast market reflects the collective estimation of an event's likelihood. For example, if a "Yes" contract is trading at $0.70, it suggests a 70% chance or probability that the event will occur. Prices fluctuate in real-time as participants buy YES and NO contracts based on new information, constantly updating the implied probabilities. When people invest their own money, they tend to make more rational and informed forecasts, leading to a market-driven probability estimate.

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Incentives and Information Aggregation

Participants are financially motivated to act on valuable information, aiming for profit. This incentive encourages thorough research and sharing of knowledge. Forecast markets aggregate diverse perspectives, combining expert analysis and public sentiment. This pooling of information often leads to more accurate forecasts than individual forecasts. As more people participate, biases can be reduced, resulting in a more representative and reliable consensus.

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Types of Events in Forecast Markets

Forecast markets cover a wide range of events. Economic indicators like employment numbers, inflation rates, and GDP growth are common subjects. Markets may also focus on business and technological developments, innovations, and social or environmental issues like climate change and public health. Additionally, election outcomes are popular topics. These diverse areas allow participants to engage with subjects they are knowledgeable about or interested in.

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What is a key benefit of earning incentive coupons on the daily value of open forecast market contracts?

A It guarantees a profit regardless of the event outcome.

B It compensates traders for having their capital tied up over extended periods before the event is resolved.

C It increases the final payout amount when the event occurs.

D It eliminates the risk of price fluctuations in the market.

Earning incentive coupons on open contracts provides traders with additional returns while their funds are tied up, especially in long-term contracts. These incentive coupons compensate them for the opportunity cost of not having immediate access to their capital before the event's outcome is known.

Mateo Explores Probabilities

Intrigued by government spending, Mateo considers the contract "Will the US National Debt exceed $37 trillion by the end of 2025?" The "Yes" contract trades at $0.91. This suggests an 91% probability that the event will occur, based on market consensus. Mateo learns that the price adjusts as traders incorporate new information. This helps him think in probabilistic terms—evaluating the likelihood of outcomes and making informed decisions based on shifting probabilities rather than fixed beliefs.

Asymmetric Payoffs in Forecast Markets

In forecast markets, asymmetric payoffs arise due to how contracts are priced. For instance, when there is a $0.91 bid for "Yes," a "No" contract can be bought for $0.10, with the $0.01 exchange fee. If the unlikely event occurs, the "No" contract pays $1, yielding a 10-to-1 payoff, while the "Yes" contract yields only 1.1-to-1. This disparity, known as the "lottery effect," can lead to the overstatement of low-probability events as participants may overvalue small chances of large gains.

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Impact on Controversial Issues

Forecast markets provide a clear picture of public opinion on divisive topics by reflecting the consensus view. Financial stakes encourage participants to think logically rather than emotionally, promoting rationality. For example, issues like climate change or national debt become grounded in probability-based forecasts rather than speculation. Seeing market probabilities can influence public perception, shifting discourse toward more evidence-based discussions and away from extreme viewpoints.

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Benefits to Society

Forecast markets encourage citizens to engage thoughtfully with important issues, aggregating diverse opinions into consensus probabilities that promote balanced understanding. This helps society grasp future possibilities, fostering an informed populace. These markets also provide valuable data to legislators, reflecting public expectations and aiding policy development. Lawmakers can use market insights to gauge public perception of proposed legislation, guiding governance.

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The mayor of Sunville, a city prone to hot weather, notices that the "Yes" contract for "Will 2025 be the warmest year on record?" is trading at $0.85 in a forecast market. How should the mayor use this information to benefit the city's residents?

A Proceed with business as usual, since forecast markets are speculative.

B Cut funding for public health programs to save money in anticipation of lower energy costs.

C Focus solely on promoting summer tourism without considering the potential impact of extreme temperatures.

D Allocate resources to prepare for extreme heat, such as opening additional cooling centers and investing in heat-mitigation infrastructure.

The high trading price of $0.85 indicates that the market estimates an 85% probability that 2025 will be the warmest year on record. The mayor can use this information to proactively implement measures to safeguard residents against extreme heat. This includes expanding cooling centers, improving public messaging on heat safety, investing in green infrastructure like parks and shade trees, and enhancing emergency services for heat-related health issues.

Thank you for learning about forecast markets.

Forecast markets are platforms for trading event-based contracts, reflecting collective beliefs about future events. They use contract prices to estimate probabilities, aggregating diverse information and promoting rational thinking. By encouraging participation and reducing biases, these markets provide valuable insights into future events, benefiting individuals and society alike. They influence discussions on controversial issues and aid policymakers in making consensus-driven decisions.

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IBKR ForecastTrader is a product of Interactive Brokers LLC that allows clients to access and trade ForecastEx Forecast Contracts, and CME Event Contracts. Forecast Contracts are only available to eligible clients of Interactive Brokers LLC, Interactive Brokers Hong Kong Limited, and Interactive Brokers Singapore Pte. Ltd

Interactive Brokers LLC is a CFTC-registered Futures Commission Merchant and a clearing member and affiliate of ForecastEx LLC (“ForecastEx”). ForecastEx is a CFTC-registered Designated Contract Market and Derivatives Clearing Organization. Interactive Brokers LLC provides access to ForecastEx forecast contracts for eligible customers. Interactive Brokers LLC does not make recommendations with respect to any products available on its platform, including those offered by ForecastEx.

Futures, event contracts and forecast contracts are not suitable for all investors. Before trading these products, please read the CFTC Risk Disclosure. For a copy visit our Warnings and Disclosures page.

Incentive coupon subject to variation with benchmark rates. Restrictions apply.

This ForecastTrader lesson is provided within the meaning of CFTC Regulation 1.71 and is not meant to provide sufficient information upon which to base a decision to enter into a derivatives transaction.

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Learn about Forecast Markets

Introduction to Forecast Markets

Contracts and Payouts

Trading and Liquidating Positions

Mateo's First Forecast Market Trade

How can a trader liquidate their position in a forecast market before the event outcome is known?

Incentive Coupon Payments on Contracts

Mateo Experiences Fluctuations and Incentive Coupon Payments

Market-Based Probability Estimation

Incentives and Information Aggregation

Types of Events in Forecast Markets

What is a key benefit of earning incentive coupons on the daily value of open forecast market contracts?

Mateo Explores Probabilities

Asymmetric Payoffs in Forecast Markets

Impact on Controversial Issues

Benefits to Society

The mayor of Sunville, a city prone to hot weather, notices that the "Yes" contract for "Will 2025 be the warmest year on record?" is trading at $0.85 in a forecast market. How should the mayor use this information to benefit the city's residents?

Thank you for learning about forecast markets.

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Interactive Brokers Canada Inc.

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Interactive Brokers Singapore Pte. Ltd.

Introduction to Forecast Markets

Contracts and Payouts

Trading and Liquidating Positions

Mateo's First Forecast Market Trade

How can a trader liquidate their position in a forecast market before the event outcome is known?

Incentive Coupon Payments on Contracts

Mateo Experiences Fluctuations and Incentive Coupon Payments

Market-Based Probability Estimation

Incentives and Information Aggregation

Types of Events in Forecast Markets

What is a key benefit of earning incentive coupons on the daily value of open forecast market contracts?

Mateo Explores Probabilities

Asymmetric Payoffs in Forecast Markets

Impact on Controversial Issues

Benefits to Society

The mayor of Sunville, a city prone to hot weather, notices that the "Yes" contract for "Will 2025 be the warmest year on record?" is trading at $0.85 in a forecast market. How should the mayor use this information to benefit the city's residents?

Thank you for learning about forecast markets.

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