Sound and Fury

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World Cup gives insight into financial crisis

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It has been reported today that JP Morgan analysts have predicted that England will win the world cup. Their analysis suggests that the schedule favours England over the tournament favourites Brazil and Spain. But there’s a flaw in their reasoning. One of the factors looked included in their model is the odds offered on various teams winning on Betfair.com. Since betfair is an English website, it seems there is a danger of “the market’s” assessment of relative likelihoods of various teams winning being skewed in favour of the home country. My guess is that this analysis’ outcome wouldn’t be robust if you substituted in a different betting exchange’s odds, say from a different country. Imagine taking, say, Italy’s biggest betting exchange and using their odds. I doubt England would prevail there. So either they should pick the odds offered by a betting exchange from a country with no realistic chance of winning (so the team with a chance don’t have their odds skewed), or aggregate the odds of various markets from various countries.

And how does this give an insight into the financial crisis? The mistake made in both cases is the same. It is to assume that the market price reflects the value of the asset. Economists call this the Efficient Market Hypothesis. In the world cup prediction case, the assumption is that odds offered reflect the real chance of the outcome occurring.

Odds offered by proper bookies obviously don’t straightforwardly reflect their expert opinion of the chance of the event: bookies shorten odds in order to make a profit. (Consider roulette: betting on red doubles your money, but the chance of red is slightly less than a half, and therein lies the house advantage; the profit.) Another confounding factor here is that odds on England offered by English bookies are shortened a lot, since many more people will bet on England  here than in other countries (regardless of odds), so if England did win bookies would have to pay out a lot. So bookies make the odds shorter to limit their exposure to huge payouts. But betfair isn’t like a normal bookies. It’s a betting exchange. It’s much more like a stock exchange. The thing that is being bought and sold are bets. This should counteract some of the distorting effects inherent in standard bookie’s odds. But there is still a bias in favour of England, I think. People on betfair aren’t all betting as disinterested fully informed rational agents. So there is no reason to think the odds offered on England really do reflect the best estimate of England’s chance of winning. (I mean, come on. Emile Heskey is in the squad. Compared with Spain, who will probably leave Dani Guiza on the bench…)

To be clear: the problem is not with the idea of using the market in general, but the problem is that the betting exchange they used has a clear bias that JP Morgan don’t seem to have acknowledged. (From what I’ve read in the papers. Maybe they did, but I expect not). The insight into the financial crisis is this: if JP Morgan didn’t spot this flaw and they SURVIVED, imagine how dumb the financial companies that folded must have been!

Here’s another take on analysing the world cup which won’t be as popular in the England, since it doesn’t have England winning…

Important caveats: I know very little about economics and even less about football. But this is the internet, so my opinion is just as important as all those so called experts.

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Written by Seamus

May 19, 2010 at 11:32 am

Posted in random

Tagged with , ,

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