Banning This Hedge on Election Risks Is Shortsighted

The Commodity Futures Trading Commission appears to have little respect for the power of markets, going by their proposal to ban futures contracts on electoral outcomes.

Elections have enormous financial consequences affecting future tax rates, trade policy, regulation and government spending. But instruments such as forward contracts, insurance policies or bets don’t provide effective ways of hedging these risks. Each election affects so many things, and in such complex ways, that — despite the passionate conviction of partisans — they likely have expected present values that net out pretty close to zero for most individuals and companies. This is precisely the kind of exposure that requires futures markets.

Unfortunately, proponents of election futures have marshaled only weak arguments. One is that the instruments would allow hedging of election exposures. But for the reasons above, we’ve seen very little demand for these hedges, and if anyone did want them, they could negotiate forward contracts or insurance policies for that job.

The other argument is that the contracts would give valuable information. The objection to this is markets give only “market-implied” probabilities, which differ significantly and systematically from actual probabilities. Moreover, as Fischer Black famously pointed out, efficient markets get prices within a factor of 2 about 90% of the time (I had advised him to say, “half the time,” and he considered it). If a futures contract gave Donald Trump a 50% chance of winning the 2024 election, we’d be 90% sure his chance was between 25% and 100%, and we know more than that already.

The co-conceiver of the Black-Scholes theory of options pricing argued that the point of markets was not to get prices precisely right — that’s impossible to even define — but to coordinate economic activity. If oil refiners are planning based on an assumption of high oil prices and airlines are selling tickets based on low assumed oil prices, there will be inefficiencies and deadweight losses.