What can finance learn from sports betting?

by on February 7, 2016 at 12:49 am in Data Source, Economics, Games, Sports | Permalink

Tobias J. Moskowitz has a recent paper on this question, the results are illuminating:

I use sports betting markets as a laboratory to test behavioral theories of cross-sectional asset pricing anomalies. Two unique features of these markets provide a distinguishing test of behavioral theories: 1) the bets are completely idiosyncratic and therefore not confounded by rational theories; 2) the contracts have a known and short termination date where uncertainty is resolved that allows any mispricing to be detected. Analyzing more than a hundred thousand contracts spanning two decades across four major professional sports (NBA, NFL, MLB, and NHL), I find momentum and value effects that move betting prices from the open to the close of betting, that are then completely reversed by the game outcome. These findings are consistent with delayed overreaction theories of asset pricing. In addition, a novel implication of overreaction uncovered in sports betting markets is shown to also predict momentum and value returns in financial markets. Finally, momentum and value effects in betting markets appear smaller than in financial markets and are not large enough to overcome trading costs, limiting the ability to arbitrage them away.

SSRN and video versions of the paper are here.  The underlying idea here is neat.  The marginal utility of consumption is unlikely to be correlated with the outcomes of sporting events, so we can test some propositions of finance theory without having to worry much about those risk factors.  Lo and behold, a version of momentum results still holds up.  And if you would like an exposition of that approach, do see my earlier dialogue with Cliff Asness.  And here is Cliff on Fama on momentum.

1 Ray Lopez February 7, 2016 at 1:25 am

My five second analysis: is this simply saying most people bet on their favorite team, regardless of the odds? Momo is also related to “popularity” as in say the Redskins finally going into the playoffs will result in herd behavior from fans. I personally bet against the team I wish to win, so I win either way.

2 Heorogar February 7, 2016 at 10:10 am

“I personally bet against the team I wish to win, so I win either way.” Very good. Avoid risking the rent money.

3 ptuomov February 8, 2016 at 10:06 am

This makes no sense for the reason you stated. Your team winning and you having money are not perfect substitutes, are they?

What matters is whether the marginal utility of money is higher or lower in the state that your team wins. I think that people in general want to go out and celebrate and spend money after their team wins. They don’t seem to do that when their team loses, they just go home. From that, I’d infer that the marginal utility of money is higher in the state of the world in which your team wins. Thus, the correct hedging strategy that maximizes expected utility is to bet for your own team.

4 prior_test February 7, 2016 at 1:31 am

‘What can finance learn from sports betting?’

How to skim as much money as possible at the edge of legality/illegality?

5 Moreno Klaus February 7, 2016 at 6:55 am

I think they already do that.

6 BC February 7, 2016 at 3:34 am

“Lo and behold, a version of momentum results still holds up.”

Questionable. The profitability of the the trading strategy is not enough to overcome transaction costs. Also, the risk-adjusted return premia are much smaller than that found in financial markets. Then, it would seem that once one removes the systematic risk of the financial market strategies, there is very little information inefficiency in the idiosyncratic sports markets that is not explained by transaction costs. These results seem to support the notion that most, if not all, of the momentum and value returns (in excess of transactions costs) found in financial markets are compensation for systematic risk rather than evidence of behavioral inefficiencies.

I am actually somewhat surprised. I would have thought that sports betting markets would be much less informationally efficient than financial markets due to fewer professionals and more recreational bettors. Maybe, it doesn’t take that many informed “arbitrageurs” to keep the betting lines within transactions costs distance of “fair”.

7 B Cole February 7, 2016 at 8:21 am

I agree. EMH rules.
There was no housing bubble.
The Fed should give up “popping bubbles.”
In fact, the Fed should promote growth, as competition and EMH are great guard rails.

8 errorreport February 8, 2016 at 1:49 pm

The transaction costs are at least an order of magnitude larger and so there is a difficulty in directly comparing them.

9 oli5679 February 7, 2016 at 6:28 am

Uniformed sports betting has a negative expected return and so there must be a behavioural explanation for the majority of sports bets.

10 ant1900 February 7, 2016 at 10:49 am

Check out the book The Missing Risk Premium.

In my view, a major driver of sports betting is in an attempt to signal that the bettor know a lot about sports. So-called alpha discovery.

11 Moreno Klaus February 7, 2016 at 11:51 am

Yes and money laundering of course.

12 y81 February 7, 2016 at 12:00 pm

This mystery surrounds all gambling. Apparently, the second derivative of the money/utility function turns positive at some high value of the money variable.

13 Scott Sumner February 7, 2016 at 12:35 pm

BC beat me to it—I read the result as being somewhat supportive of markets being roughly efficient.

14 Jesse Koltes February 7, 2016 at 2:39 pm

One of AQRs links to what is likely a quality a quality score is missing. Too bad!

15 Sunil February 8, 2016 at 4:51 pm

I don’t know all that, but I believe one thing that we need to learn is never to gamble or bet, as that’s the way we will lose, so that’s why we need to do real work. I do Forex trading and where it is so much easier for me with OctaFX broker given their lovely conditions with low spreads which starts from just 0.1 pips with high leverage up to 1.500 plus much more to help me gain consistent profits.

16 Zach February 9, 2016 at 4:38 pm

An interesting contrapositive to the idea that most sports betting is recreational, with a negative expected return:

The people who make money from gambling tend to be grinders who are neurotic beyond belief.

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