Markets Have a Time Tough with Longshots

This Sunday, the New England Patriots are playing the San Francisco 49ers. In a football sense, this probably won’t be a very interesting game. The Patriots are quite good this year, and the 49ers are not.

However, in a betting sense, this is a very interesting game. The reason is because the Patriots are favored to win by 13 points. I’ve actually seen as high as 14 points, but let’s say 13 for now. It’s very unusual for a visiting team to be favored so strongly. This will be the widest spread for a visitor in three years.

What does this have to do with financial markets? Well, let’s take a step back and view betting markets as cousins of the stock market. Both have buyers and sellers who set prices, and the participants are trying to beat the odds.

Just like index funds, the data shows that point spreads are, for the most part, pretty accurate. It’s hard to beat them over the long haul, especially when include the vig (the bookie’s cut).

But there is a blind spot for the market, and that’s in extreme events. The market (meaning people) are pretty good at setting odds for most things. But once you start getting to extremes, they’re not so good.

To my mind, the best example is lotteries. In a rational world, lotteries wouldn’t exist. They make no sense. But they do exist because people play for the extreme odds. If the payoff wasn’t extreme, they wouldn’t play.

We see this in the stock market when high valuation stocks tend to underperform. People invest in biotechs similar to lottery tickets—they expect a few losers for that one giant winner. I suspect that’s why value stocks have outperformed historically. It’s not so much that they’re better, it’s that the high growth/high valuation stocks underperform. By definition, that means the opposite will outperform.

Since 1978, there have been 175 games in which a visiting team has been favored by 10 or more points. Excluding three “pushes,” the visiting team has failed to cover the spread in 104 games, or 60.5% of the time. That’s pretty high for the sample size. Nothing else comes close.

If the market truly has a problem pricing extreme events, is such a football betting strategy exploitable? Eh…not really. These games come along an average of four or five times a year.

Just like investing, it pays to be disciplined and patient.

Posted by on November 17th, 2016 at 12:28 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.