Sports betting and financial markets have a lot in common. The wisdom of the crowd is setting prices and the markets are highly efficient, making it difficult to outperform.
In economic terms, a market in which it is difficult to persistently exploit mispricings after the expenses of the effort is called “efficient.” Markets are made efficient by the “wisdom of crowds.” As James Surowiecki demonstrated in his book, The Wisdom of Crowds, the evidence from many fields is that under the right circumstances, large groups of people are collectively smarter than individual experts when it comes to problem-solving, decision-making, innovating and predicting. The four requirements of wise crowds are (1) diversity of opinion, (2) independence of members from one another, (3) decentralization and (4) a good method for aggregating opinions.
An overwhelming body of evidence supports the view that while the financial markets are not perfectly efficient, they are highly efficient, with fewer active managers able to generate statistically significant alphas than would be randomly expected. The annual S&P Active Versus Passive Scorecard has been demonstrating this for almost 20 years. The reason is that the four requirements for the wisdom of crowds to prevail exist in financial markets.
Financial markets are not the only ones that are highly efficient. Betting markets have long been viewed as a testing ground for Eugene Fama’s efficient market hypothesis (EMH). Testing the EMH is more straightforward in betting markets than in typical financial markets because there is a fixed time when a bet’s value is revealed, i.e., when an event ends. Because most of us don’t know anyone who has become rich betting on sports, we know intuitively that sports betting markets are efficient. However, intuition is often incorrect. It helps to have evidence supporting your intuition. Before we look at the evidence, however, we need a definition.
Point spreads and random errors
An “unbiased estimator” is a statistic that is, on average, neither too high nor too low. The method of estimation does not always produce estimates that correspond to reality, but errors in either direction are equally likely. It turns out that the point spread is an unbiased estimate of the outcome of sporting events – while it is not expected to be correct in every instance, when it is incorrect the errors are randomly distributed with a zero mean.
Are sports betting markets efficient?
Daniel Hickman contributes to the literature on market efficiency with his study, Efficiency in the Madness? Examining the Betting Market for the NCAA Men’s Basketball Tournament, published in the July 2020 issue of the Journal of Economics and Finance. The NCAA men’s basketball tournament is one of the most popular sporting events in the world and gives rise to a substantial betting market. According to a press release from the American Gaming Association, Americans were expected to wager $8.5 billion on the 2019 event, with 4.1 million individuals placing a bet legally and another 7.6 million estimated to place bets illegally.
The data for Hickman’s analysis is from the website Odds Shark, which provides closing betting line information for each of the NCAA tournament games played from 1996 to 2019. Hickman examined the efficiency of this market to determine whether bettors display any significant biases.
Before reviewing the results, it’s important to understand two points. First, professional betting is not a zero-sum game, as would be the case when betting between friends. The bookies earn what is called the vigorish – in order to win $10, one has to bet $11. With a vigorish of 10%, a bettor would have to be correct 52.4% of the time to come out ahead. And that assumes there are no other costs involved (including the value of the time it takes to study the teams, analyze the spread, and make the bet). The result is that if the favorite covers the point spread anywhere between 47.6 and 52.4% of the time, you could not systemically bet on or against the favorite and win after costs – and the market would be deemed efficient. Second, the professional bookies are not the ones setting the final odds or the number of points that will be scored by either or both teams. They only set the opening line. As bets come in, prices move, reflecting the views of bettors. With that understanding, we can review Hickman’s findings:
- The results indicate the market operates at an efficient level, with very little in the way of detectable bias based on seeding. The higher seed wins a high percentage of games but covers the spread just under 50% of the time.
- The market does a remarkably efficient job of forecasting the actual score for the higher-seeded teams in tournament games, with a mean forecast error of just 0.05 points. The score of the lower-seeded teams is underestimated by roughly 0.5 points.
- The higher seed covered 49.7% of the time during the first round of games, where the discrepancy between teams is generally the greatest. The higher seed covered 50.7% of the time in the second round of games, and 47.3% in rounds three through six (slightly below the hurdle of 47.6% needed to cover the vigorish).
- There is weak evidence that heavily favored teams are “overvalued” by bettors. Teams that are favored by more than 20 points cover 47.8% of the time (insufficient to overcome the vigorish).
- The market looks more efficient if we lower the bar to games with betting lines of at least 12 points. In those cases, the favorite covers 49% of the time.
- The most noticeable anomaly is a tendency for teams from the Atlantic Coast Conference (ACC) to cover the spread less than would be expected in an efficient market, particularly in the opening round.
- Another anomaly is that second-seeded teams cover the spread less than expected in an efficient market. This is the only seed that shows a statistically significant anomaly.
Here’s another example of the efficiency of sports betting markets. In a study covering six NBA seasons, Raymond Sauer found that the average difference between point spreads and actual point differences was less than one-quarter of one point.1 When you consider that on average the market guessed the actual resulting point spread with an error of less than one-quarter of one point, and with the cost of playing of 10%, it is easy to understand why we don’t know people who have become rich betting on sports. And it is easy to see that the market in sports betting is efficient.
In case you think the betting market in basketball is just an anomaly, here’s another example from English professional football (soccer). Guy Elaad, James Reade and Carl Singleton, authors of the 2020 study, Information, Prices and Efficiency in an Online Betting Market, looked at the odds (or prices) of prices set by 51 online bookmakers, for the result outcomes in over 16,000 association football matches in England over the period 2010-2018. They found that, “there is no statistically significant evidence at standard levels (5% or 1% level, two-tailed tests) that bookmaker odds excessively price in any particular match result outcomes.”
Horse racing presents an even more amazing outcome, especially when you consider the following. My mother loved to go to the track. Like many people, she chose the horses she would bet on by either the color of the jockey’s silks or the name of the horse. If the jockey wore purple, forget about it; she hated the color purple. And she always bet on the #3 horse in the first race. Now, there are fans who go to the track and make a “science” of studying each horse’s racing history and under what racing conditions the horse did well or poorly. And perhaps these experts even attend workouts to time the horses. Thus, these “experts” are competing against people like my mother. Yet, the final odds, which reflect the judgment of all bettors, reliably predict the outcome – the favorite wins the most often, the second favorite is the next most likely to win, and so on. It gets even better in that a horse with 3-to-1 odds wins about one-fourth of the time!2
The collective wisdom of the crowd is a tough competitor indeed.
A bunch of amateurs are setting odds and point spreads at prices that make it extremely difficult for even the most knowledgeable sports fan to exploit any mispricing, after accounting for the expenses of the effort. The important term here is “after expenses.”
What do sports betting markets have to do with investing?
As we have seen, even though a bunch of amateurs are setting prices in sports betting markets, it is difficult to find pricing errors that can be exploited. In the world of investing, where about 90% of all trading is done by large institutional traders, these sophisticated investors are setting prices, not amateur individual investors. With professionals (instead of amateurs) dominating the market, the competition is certainly tougher than it is in the sports betting market. And we saw how difficult it is to win that game. Every time an individual buys or sells a stock, he should consider that he is competing with these giant institutional investors. He should also acknowledge that institutions have more resources. Thus, it is more likely they are on the right side of the trade, and the individual investor is on the wrong side. In fact, that is exactly what the evidence shows.
University of California professors Brad Barber and Terrance Odean produced a series of landmark studies on the performance of individual investors. One study found that the stocks individual investors buy underperform the market after they buy them, and the stocks they sell outperform after they sell them.2 They also found that male investors underperform the market by about 3% per annum, and women (because they trade less and thus incur less costs) trail the market by about 2% per annum.3 In addition, they found that those investors who traded the most trailed the market on a risk-adjusted basis by over 10% per annum.4 And to prove that more heads are not better than one, they found that investment clubs trailed the market by almost 4% per annum.5
Sports betting and financial markets are both highly efficient. In both cases, it is the collective wisdom of crowds that makes it difficult to outperform. That makes sports betting a loser’s game – it’s possible to win, but the odds of doing so are so poor that it’s not prudent to try. Thus, in the case of sports betting, unless you place a significant price on the entertainment value of gambling, the surest way to win that game is to not play. Similarly, the surest way to win the loser’s game of active investing (trying to pick stocks and/or time the market) is to not play. That doesn’t mean not investing. Instead, it means investing in low-cost funds (such as index funds) that provide systematic exposure to the risks you are willing to accept and doing so in a transparent, replicable manner.
Larry Swedroe is the chief research officer for Buckingham Strategic Wealth and Buckingham Strategic Partners.
- Raymond D. Sauer, “The Economics of Wagering Markets,” Journal of Economic Literature, 36, p. 2021-64.
- James Surowiecki, “The Wisdom of Crowds” (Doubleday, 2004), p. 13-14.
- Brad Barber and Terrance Odean, “Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors,” Journal of Finance (April 2000).
- Barber and Odean, “Boys Will Be Boys: Gender, Overconfidence and Common Stock Investment,” Quarterly Journal of Economics (February 2001).
- Barber and Odean, “Trading Is Hazardous to Your Wealth.”
- Barber and Odean, “Too Many Cooks Spoil the Profits: Investment Club Performance,” Financial Analysts Journal (January/February 2000).
Read more articles by Larry Swedroe