Gambling Markets vs Financial Markets - A Discussion
Musings on Backing, Laying, Trading, Punting, In-Running and more on the Betting Exchanges and related items of interest in the wide world of sports investing
How are betting markets organised differently to financial markets? Today on the blog Cassini discusses.
The paper “Why Are Gambling Markets Organised So Differently From Financial Markets?” has recently surfaced around my Twitter and blog community, initiated by Peter Nordsted I believe, and it is worth taking a look at even though the study is from 2004 and some of the findings may no longer be accurate, or necessarily relevant to those who use the betting exchanges for most of their sports investments. The study is US based, in that it focuses on the sports books in Las Vegas rather than High Street UK bookmakers and the betting exchanges, still relatively new in 2004, and unknown in the USA, don’t get a mention.
The paper is written by Steven D Levitt, an American economist who is best known as the co-author of “Freakanomics” and “The Impact of Legalised Abortion on Crime”, the former because it became a New York Times best-seller, the latter because it became highly controversial, to say the least.
The study in question takes a look at the role of the market maker (bookmakers, or sportsbooks), and using data from 21 seasons of NFL betting, attempts to explain why a line (spread) on a match moves very little, in contrast to the financial markets where prices change frequently and where the “prevailing price is that which equilibrates supply and demand”. For the NFL data, the price changes an average of 1.4 times, and when it does change, 85% of the time it changes by the minimum of ½ point which means that in 90% of games, at kick-off the spread has moved by one point or less from the opening price.
On the face of it, for the price to move so rarely and by such a small amount when it does move, is quite astonishing. While the paper appears to be blissfully unaware of betting exchanges, compare the generation of a spread with the formation of a price on an exchange. Exchange prices, as do most prices in free markets, settle at the point where supply meets demand, yet NFL lines are calculated, not by individual bookmakers, but by a handful of influential odds makers who are paid by large Las Vegas casinos for their services.
The paper doesn’t mention this, but in practice, the lines are ‘tested’ before they are made available to the public by being offered to known ‘sharp’ bettors ahead of time. Limited to how much they can stake, the sharps' action serves to expose any glaring pricing errors before the lines are released. The sharp benefits by being the early bird, and getting some action at a line he considers favourable, and the sports book benefits by having the opportunity to adjust the line before opening the floodgates to the public. Thus the fact that the opening line moves so little is perhaps not as astonishing as it at first appears, and the 1.4 and the 90% figures should be qualified to state that they apply only once the line is released to the general public. It’s a bit like saying that a published book contains on average 1.4 misspellings, without mentioning the proof-reading process.
A Binary Market
It is often said that bookmakers balance their books by (in a binary market) attracting the same amount of money on each outcome, so that in an even money contest, 55 units is received on each outcome, and 100 are paid out on the winner. The study observes that this is not true, and that by being aware of bettors’ preferences, the bookmakers adjust their prices to maximize their profits (while accepting some risk) rather than merely balancing their books, and taking no risk. The latter approach requires no skill from the bookmaker, but for the strategy of maximising profits to work, they need to be better than most bettors at predicting the actual outcome of sporting events.
Steven Levitt does mention UK bookmakers when mentioning big losses, writing “There are many notorious examples of bookmakers suffering large losses. It is reported that over half of all British bookmakers were bankrupted when Airborne won the Epsom Derby in 1946 (the ?rst running after World War II ended) at odds of 50 to 1.”
Although the source for this statement is quoted as Smith, 2002, it is actually from an article by Joe Saumarez Smith which was published in the March 2001 edition of Business Life, (British Airway`s in-flight magazine for business class travellers). Some readers may know Mr. Smith as the inventor of the term Asian Handicap.
A couple of other examples of bookmakers taking big losses referenced are the Frankie Dettori sweep at Ascot: In 1996, popular jockey Frankie Dettori won seven straight races, costing bookmakers an estimated £30 million (Gambling Magazine, 1999), and again from the Smith article, that “Coral Eurobet reported losses of £12million on internet betting in quarter-final round of Euro 2000 soccer championship” when all four favourites won in normal time (Portugal, France, Netherlands and Italy).
Of Favourites and Underdogs
The paper is full of statistics, but perhaps the key data is this: “Bettors exhibit a systematic bias toward favourites and, to a lesser extent, towards visiting teams. Consequently, the bookmakers are able to set odds such that favourites and home teams win less than 50% of the time, yet attract more than half of the betting action.”
Levitt calculates that by using that strategy, sports books increase their gross profit margins by 20%–30% over the strategy of attempting to balance the amount of money on either side of the wager. The paper also states: On the dimension of favourites versus underdogs, bookmakers appear to have distorted prices as much as possible without allowing a simple strategy of always betting on underdogs to become profitable.
Clearly bookmakers can only carry this strategy so far though, since intentionally under-pricing the selection known to be favourable to bettors, also means over-pricing the selection which is typically ‘unfavourable’ to bettors, and however ‘unfavourable’ a selection might be, they all have their price, or as the report phrases it “bettors who do not suffer from biases can profitably exploit the price distortion.”
The study shows that when the favourite team is the visiting team, this combination attracts 68.2% of the bets, yet it wins just 47.8% of the time. Thus, an underdog playing at home received just 31.8% of bets, but wins 57.7%of the time. [Note that to be profitable, a bettor paying the typical Vegas vig (vigorish, commission) of 10% needs to win 52.4% of the time.]
The paper concludes that sportsbooks are better at predicting game outcomes than the typical bettor. This is hardly surprising, given that setting prices is their business, but a consequence of that is that “they are able to set prices in order to exploit their greater talent, and apparently yielding greater pro?ts than could be obtained if the bookmakers acted like traditional market makers and attempted to equilibrate supply and demand, avoiding taking large stakes in the outcomes of games.
In the presence of some bettors who are as skillful in picking games as are the bookmakers, there are limits to how much prices can be distorted without creating profit opportunities. It appears that the bookmaker shave distorted prices to the point where they bump up against this limit.”
One other conclusion the author arrives at is that “In order to support this mode of price-setting, it cannot be the case that a significant fraction of bettors (or more precisely dollars bet) have better information than the bookmaker. In that case, it would be the bookmaker who would be exploited by this system. At least within my sample of bettors, I see little evidence of heterogeneity in ability to pick winners, suggesting that the bookmaker might be as good or better at picking game outcomes than any of the bettors.”
In reaching these conclusions, the author rather conveniently ignores the ability of bookmakers and sportsbooks to limit the amount of money they are prepared to take from their customers. Not surprisingly, bookmakers do not want to do business with individuals who they know are better at pricing outcomes than they are, and they are under no obligation to do so. You don’t even have to be a long-term big winner to find yourself restricted – the forums are full of tales of people who are restricted simply because they appear not to be mugs! The author seems to think that bets on either side cannot be declined, but this is not so.
Some Numbers Worth Noting
Back to some of the statistical findings of the study, and the fact that home teams and underdogs cover the spread a disproportionate share of the time has been well established in other studies too, and in other sports than American Football. For example, a seven year study of baseball results produced the following winning percentages and betting results:
Underdogs: 6917-9644 -153 units
Favourites: 9619-6891 -641 units
Even though the favourites won a healthy 58.3% of the time, bettors who backed only the favourites would lose four times as much as a bettor who backed only underdogs. Interesting, but still a losing strategy, but a little more research into the numbers revealed that if you only backed underdogs in divisional games (Major League Baseball comprises six divisions, three in the American League and three in the National League) the underdogs won 3414 games and lost 4513, but showed a profit of 191 units.
The study also found that underdogs also performed better when coming off a victory, after scoring 10 or more runs, and in the first game of a series, but the biggest edge was in the divisional games as mentioned.
For those who like to see some numbers, here are the results of a baseball strategy where the selection is a sub-set of home underdogs. They are backed if they have won six or more of their last ten games (i.e. their form is strong), and if they have won two or more home games than they have lost.
Note how the profits have fallen off in recent years, evidence perhaps that the odds makers have made some adjustments. Since 2005, this would be a losing system, but as one door closes, another opens, which is why it is important to keep looking at different ideas and not assume that even a strategy with six winning years behind it will continue to work for ever.
No Simple Strategy
The bottom line is that there is no simple strategy, such as backing all home underdogs, that will be the road to riches, but by understanding how lines are set, and how the public is likely to bet, a little research and a disciplined approach can identify where the value is, and in US sports especially, that more often than not appears to be with the underdog.
While you will almost certainly win less than half of your underdog bets, you can still finish with a profit.
If you know that the Las Vegas sports books know that the public will back the Green Bay Packers, the New York Yankees or the Boston Celtics at (almost) any price, then opposing those teams and backing the opponents seems almost too obvious. Fortunately for us, there seems to be no end to punters happy to ‘support’ their favoured teams, with little or no regard to value. Mug punters I believe the term is.
The author ends with the observation that “Perhaps, then, a fundamental difference between gambling and financial markets is that it is possible in gambling to find and hire a small set of individuals (the odds makers) who can systematically do better in predicting game outcomes than can bettors overall.”
Perhaps a more accurate conclusion would be that a fundamental difference is that whereas the financial markets are open and anyone can buy and sell financial investments, the sports investment markets in the area of the study are different because they are controlled by a small number of corporations, and they are able to accept risk when they find it favourable to do so, and decline risk when it is not.
The concept of Exchange Betting has yet to reach the United States, in no small part because of lobbying from the casinos in Las Vegas and Atlantic City who, for obvious reasons, do not want to relinquish their control of the domestic betting markets.
It’s easy to be the best at what you do, if you have the power to stop anyone better than you from playing the game.
You can follow Cassini on Twitter @calciocassini
And visit Cassini's blog : GreenAllOver.blogspot
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