Following the launch of Interactive Brokers’ ForecastEx platform, which allows investors to buy ‘yes’ or ‘no’ contracts based on stated outcomes for specific indicators, Artemis spoke to Patrick Brown, Head of Climate Analytics at the firm, about how these contracts allow investors to access risk-linked returns, as well as some of the key advantages they bring towards the industry.Forecast contracts provide a way for investors to trade their predictions on climate and economic outcomes, to either hedge against market uncertainty, or profit from their insights.During a recent interview with Artemis, Brown explained how these contracts are an efficient way for investors to access risk-linked returns.ForecastEx hosts prediction markets, and the most well-known use of these markets is information discovery.

Speculators take financial positions on the outcome of future events, which provides a market estimate of the probability that an event will occur.That information is tremendously valuable, but we’re also exploring the high potential for these markets to help with risk hedging and risk transfer,” Brown told Artemis.“For example, we have a contract for ‘will a major hurricane hit Miami-Dade County in 2025,’ and let’s say, for simplicity, its probability is around 10%.

Entities with significant exposure to that event would want to hedge that risk by buying YES contracts at 10 cents each.If the event occurs, they would receive $1 per contract, resulting in a net gain of 90 cents per contract.We also anticipate that, due to risk aversion, hedgers would be willing to pay more than the true actuarial value of 10 cents per contract.” Brown continued: “So, if the YES price was bid up slightly, say, instead of the true value of 10 cents, the market was clearing at 14 cents, then that means people are buying NOs at a discount.

NOs are actually worth 90 cents in this example, but they are being bought at 87 cents, implying a positive return on investment.And something innovative about this is that these NO buyers could be made up of many retail investors putting in as little as literally 87 cents at a time.” In terms of how these contracts can be beneficial for investors, Brown noted: “Using the example I just mentioned, if the true value of NOs is 90 cents per contract but they are available at 87 cents per contract, there is an edge or an expected return of $0.90/$0.87 = 3.45%.Additionally, Interactive Brokers offers a 3.83% incentive coupon on the collateral, so the overall annual expected rate of return in this example would be 3.45% + 3.83% = 7.28%.

This could become more attractive if you consider that the bulk of hurricane season is concentrated in about four months and thus the full risk premium could be earned over that abbreviated timeframe.” “If the risk hedgers bid up the YES price more, then the NO rate of return would be even larger.Also, if NO investors diversify across a sufficiently broad suite of NOs that are relatively uncorrelated with each other, that rate of return would have a narrow uncertainty range and a small likelihood of being negative.” Brown continued: “Furthermore, if that NO package is included in a larger investment fund of stocks and bonds, you could boost Sharpe ratios by achieving higher returns for the same level of risk or get less volatility for a given rate of return, because this package of NO Forecast Contracts is uncorrelated with the broader business cycle.” A key topic that Brown also discussed with Artemis was the advantages that forecast contracts bring in comparison to parametric products.“In terms of advantages over parametric insurance, in an efficient market, this would be a totally free hedge, with zero expected loss.

That’s in contrast to how traditional insurance/reinsurance works, where we pay a risk premium and buy it at an expected loss.Part of this loss pays for the overhead and profits of the insurance or reinsurance company.“However, we anticipate that these markets will equilibrate between the true actuarial value and what it would cost to buy alternative parametric insurance products from insurance companies.

So ultimately it would not be a totally free hedge, and there would still be a risk premium, but since you are cutting out the support of the (re)insurance company, it would be more efficient and less expensive than the cost of (re)insurance in the current system,” Brown explained.Another key advantage that Brown highlights is the transparency and simplicity of how these forecast contracts are priced, as the price directly reflects the market-estimated likelihood of the event occurring, which makes it easier to determine if the contract is fairly priced compared to evaluating the premium of a traditional (re)insurance product.“A third significant advantage is the speed and flexibility with which a participant can adjust their position in terms of how much coverage they want.

With sufficient liquidity in the markets, participants can increase or decrease (including closing out) the size of their position easily at very granular increments, at any time upon receiving new information.So, for example, a utility company could note that one of the best weather models has just begun to predict the formation of a major hurricane in the Caribbean, and they could act immediately to get ahead of the market and buy YES Forecast Contracts as coverage.Having said that, there are disadvantages as well, so we don’t see these as replacements for traditional re(insurance) products but rather complements that offer unique features” Brown added.

To end, Brown provided Artemis with Interactive Brokers’ outlook for its forecast contracts in 2026 and beyond.“If we want these markets to move beyond speculation and information discovery into use cases like hedging and insurance, we need broad participation.“At the moment, you can’t get $10 million in coverage in our markets because there’s not enough counterparty to transfer the risk to.

This liquidity ‘cold start problem’ has previously prevented such efforts from succeeding, but the environment has changed in several key ways today, leading us to believe we can overcome it.In fact, we think these markets are primed to reach critical mass and then take off,” said Brown.Adding: “For one thing, we have an improved regulatory environment today.

ForecastEx is a CFTC-registered Designated Contract Market (DCM) and Derivative Clearing Organization (DCO), and most previous efforts along these lines never achieved regulatory legitimacy at this level.” Looking specifically at disaster insurance applications, Brown suggests that there is more interest than there ever has been in climate change influence towards weather and climate extremes, which ultimately raises the profile of these markets.“Along those lines, potential ways to mitigate increasing insurance rates are topical and garner more interest than they have previously,” Brown added.“Specific to Interactive Brokers, our Forecast Contracts offer an incentive coupon that pays participants interest on the live market price of their position.

This incentivizes participants to take and hold positions on events further out into the future than other prediction markets – something that is necessary for climate change-related applications.Additionally, Interactive Brokers has a considerable client base on the platform, which makes it easier to entice participation and overcome the cold start problem.“The call to action right now is to explore these markets and try them out on Interactive Brokers’ Forecast Trader.

The risk can be as small as desired because you can literally put in as little as 10 cents to buy a single contract priced at 10 cents.The idea is that as we get more participation and the markets become more liquid, critical mass will be reached and the downstream insurance and hedging applications will become unlocked,” Brown concluded...

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