I feel this is more “limits of PredictIt” rather than “limits of prediction markets”. Doing the equivalent analysis for Betfair for someone in the UK. (2% charge on profits, no fee for withdrawing).
Right now the market for Trump to win is (£1200) 2.78 / 2.80 (£7421)
Those imply probabilities of 35.97% and 35.71%
After fees, 36.44% and 35.00%.
That’s not a bad spread, and you can do this in much more size. (If you’re willing to work a bit, you can comfortably get on £10,000s at prevailing levels).
We pay no taxes on gambling, so there’s none of Section III to worry about.
(Admittedly, once we start talking about even more serious size we run into Betfair’s Premium Charge, but for your average UK based rationalist, I don’t think Betfair is as bad a prediction market as you’re making out).
I think it would be extremely material for the 2020 Presidential Election. Lets say for sake of argument that Biden winning means the TCJA gets partially reversed and corporate tax rates go up 2%. That would have an extremely large (downward) impact on stock prices.
The market cap for stocks is huge O(10^13) compared to amounts wagered on the Presidential Election O(10^8), so any effect is going to swamp prediction markets.
However, I don’t believe that this effect is material to prediction markets at the moment.
1/ Prediction markets just aren’t super efficient. Compare PredictIt (41%), Betfair (36%) and various other venues to see the kind of differences out there in estimates for the odds of Trump winning re-election.
2/ Volumes aren’t super high, so this sort of hedging the author talks about is a long time away.
3/ Financial actors have much more liquid ways of hedging election risk than hedging in thin prediction markets.