I don't know how to reply on your blog, so I write my thoughts on a couple of points here.
An event like “a hurricane appears before the end of the year” may harm an insurance company that offers flood insurance, without there being some firm that benefits by the same amount who wants to take the other side of the risk.
The bet on the event itself is already the insurance. Or viewed differently, the insurance itself is a bet in some kind of prediction market on the event. Which goes to show that it does not need two economic actors with opposite exposition to some event, as in your example of the baker and the farmer w.r.t wheat prices, but it is enough that two actors have different exposition to some event. Though of course in the case of non-opposite exposition there will have to be some kind of premium for one of the sides, meaning that the market price can not be interpreted simply as a probability of the event happening.
Edit: The more I think about it, the more I have to disagree with the basic point about liquidity. For a proper market there needs to be unbiased participant and the person being affected by the event. And there always is the second person or the outcome of the event is without any meaningful economic consequence. Weather affects groth of plants, avenues visited by customers and traffic for transport of goods. Sports outcomes affect a populations happiness and their choices of activity afterwards. Scientific results make specific products plausible or impossible. And so on.
If I am affected by a specific outcome of an event in a positive way, I can reduce my exposition by betting on the opposite outcome and increase my exposition by betting on the exact outcome. If there is a person being affected in opposite ways than I am, we can take the opposite sides of the bet. Else I need someone willing to merely take on some more risk than he is already exposed to, though the person will want to be compensated for that additional risk in some way. I wonder, is this distortion measurable so to recover the "underlying" probabilites?
I think your point is correct that if there is only economic exposure on one side of a market, then it affects the interpretability of the market prices, as it then becomes an insurance market which requires a premium for the other side of the trade. (With normal insurance, you pay the premium upfront and the insurance underwriter invests that money for earnings, so insurance prices are actually much closer to the actuarially correct price than one would naively expect.) Depending on the size of the market, though, the premium could be small.
I agree that a...
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