Behavioural Economics in Sports Betting
Strolling in a certain library a few weeks ago we came across a book titled, “Misbehaving – The Making of Behavioural Economics,” written by Richard H Thaler. It is a regularly cited academic book in the field of behavioural economics, and its main idea is to disprove the conventional economics’ assumption that the markets are actually shaped-up by various rational forces. Let’s learn how this idea works in the field of sports betting.
EMH or Efficient Market Hypothesis
Efficient market hypothesis has been a hard core belief in the economic world for a long time now. Simply put, EMH means that there is nothing wrong in how various items are priced in the financial markets throughout the world. And that none of those items is overpriced or underpriced.
Talking about it in a sports betting scenario, efficient market hypothesis means that the odds set by the bookmakers represent the actual probability of a certain sports outcome, after adjusting the bookmaker’s margin. If this hypothesis was true, then no sports bettor or trader would ever be able to make any long-term profits in this industry. Or rather putting it differently, any long-term profits made in this industry would be considered purely a matter of luck, instead of skill.
However, this hypothesis has been proven incorrect in several cases, for instance, so many times during the English Premier League we’ve argued that the price on a certain team was just not right.
So, what exactly is it that these odds represent?
It’s a given that even if a bookie is well aware of the actual probability of a certain outcome, it wouldn’t price it very differently from the marketplace, because if it does so it would be risking getting into a position of offering arbitrage opportunities and/or becoming uncompetitive.
Traditional sports betting wisdom suggests that the prices can be considered closest to the actual estimates if there are plenty of traders in a certain market. On the other hand, higher number of traders may also mean more noise.
In the sports betting world, the real value of a certain outcome actually depends on the outcome itself. Hence, if you were to question if the odds at evens are true, the quickest way to answer that question would be through a simple analysis involving all past odds at evens and then seeing if they occurred half of the times or not. As it’s pretty hard to assign true value to a particular asset in the financial world, academic researchers often use betting markets in the form of a microcosm of the financial markets.
Pricing various betting outcomes
The act of pricing various betting outcomes is usually about anticipating others’ opinions about the correct prices. An excellent way of looking at it is through a competition wherein individuals try guessing what the two thirds of average of all guesses would be.
In fact, we had run this guessing game too (in fact, a version of it) and found the winning outcome to be 20. Apparently, the winner seems like a level II thinker (based on Thaler’s explanation).
If all numbers need to fall between 0 and 100 (randomly), then the average would come out to 50. The two thirds of it would be 33 (as would be reasoned by a level I thinker). The correct number would work out to two thirds of this if everyone does it, which would be 22 (as realised by a level II thinker).
If we continue ad infinitum at this rate, the Nash equilibrium would work out to 0. As per Thaler’s book, if all the participants had guessed zero, what would be the chances of anyone changing his/her guesses? The winning number came out to be 13 when Thaler ran this competition for financial Times.
Making an assessment of fair prices
Although disproving efficient market hypothesis has been the key for various behavioural economists, they haven’t done it without providing the possible causes. We found the mental accounting section of this book highly stimulating in this regard. The concept of mental accounting refers to behavioural features which may limit the optimum use of our monetary funds.
Couple of such important items are our immense love for bargain deals, combined with utter distaste of sunk costs and rip-offs. The former is based on the fact that we often purchase items if they are priced attractively instead of them being needed by us, explaining why a large majority of shops are on sale all year long.
Our perception of rip-offs is also slightly different. Someone sitting next to us during one of our low-cost airline flights willingly purchased 3 wine bottles at 6 euro each, even while constantly complaining of high costs of drinks in the English pubs. Quite obviously, the English pub prices are nowhere close to how the in-flight drinks are priced! Furthermore, if she had waited longer she could’ve bought a much better wine bottle for around € 12 upon landing. Shelling out 6 euro per bottle on a flight didn’t at all seem like a rip-off to her! In the same way, we may get tempted to place a bet just because it feels good to do so, instead of it actually being a value bet.
Sunk cost is another important mental accounting feature. For instance, a subscriber to gym membership may visit the gymnasium more often simply because he had paid for it in advance, even though his attendance may fizzle out after some time, implying that hurt related to non-utilization of already spent money dies off with time.
Application of behavioural economics in the field of sports betting
Talking from the perspective of sports betting, you must be extremely careful while considering sunk costs. For instance, if you had bet on the possibility of Chelsea winning the English Premier League three weeks ago, it shouldn’t restrict you from betting on some other team winning the League two weeks down the line, in the light of fresh information. Many people fail to understand how can someone bet on a certain team winning its group, and then ending up last in a certain tournament, with bets placed at different times of the tournament! The danger lies in heavy betting, solely with the intent of making back the lost money.
To conclude, the book “Misbehaving: The Making of Behavioural Science” is full of history suggesting how economic theory has evolved over a period of time to finally consider that all market participants aren’t perfectly rational after all!