Why are Gambling Markets Organised So Differently from Financial Markets?

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Citation: Steven Levitt (2004) Why are Gambling Markets Organised So Differently from Financial Markets?. The Economic Journal (Volume 114) (RSS)
Download: http://pricetheory.uchicago.edu/levitt/Papers/LevittWhyAreGamblingMarkets2004.pdf
Tagged: Economics (RSS) Economics (RSS), Gambling (RSS)


The paper uses a unique data set to explore why sports betting and financial markets differ in structure. In the former, a bookmaker typically sets prices (i.e. spreads), which change little if at all. In the latter, market makers match buy and sell orders at a market clearing price, which changes often.

Theoretically, a bookmaker can exploit bettors' systematic biases to increase profitability, while taking on some risk of loss (by contrast a market clearing price would ensure no loss for the bookmaker -- trading profits would be exactly half of the "vig" paid by losing bettors). A bookmaker's exploitation of bettors' biases is also limited by the potential for rational bettors to exploit distorted prices.

The paper's data are sourced from a contest held by an online bookmaker during the 2001-2 National Football League season, with 285 entrants making 19,770 bets on 242 games. There are several shortcomings with these data stemming from the contest -- bettors are attempting to win a contest, not risking money on individual games (though there was a $250 entry fee, all returned as prizes), it was not possible for bettors to reveal intensity of preferences across games, entrant attrition, and the bets and bettors are not likely to be representative of random sports bettors. However, these data include quantity of bets on each side of a wager, in addition to price -- quantity is virtually never available.

The data show that prices (which were virtually identical to those at online and Las Vegas bookmakers) did not equalize bets on each side of the wager. Approximately half (50-55%) of bets were placed on the team with the most bets in only 20% of games (if bettors were independent and had no preference between bets, this would be true in 2/3rds of games), while in almost 10% of games, more than 80% of bets are made on one team. Bettors seem to have systematic biases, in particular for visiting favorites and against home team underdogs.

The author (Levitt) calculates that exploiting such biases such that wagers are not equalized allows bookmakers to increase gross profits from 5.0% to 6.16%, an increase of 23%. Levitt also finds that these data provide no evidence that some bettors are more skilled than others, and very tentative evidence that aggregating wagers increases accuracy.

The paper concludes that bookmakers are better at predicting game outcomes than bettors, enabling the former to set prices that obtain higher profits than those that would equalize bets on each side. Levitt says that financial markets are more complex and market makers are not better predictors than other participants, supported by evidence on the inability of fund managers to systematically beat market indexes.

Theoretical and practical relevance:

The paper acknowledges that understanding why competitive pressure does not eliminate excess bookmaker profits is an unanswered question, and does not speculate (if he had, obvious starting places would include differing participant objectives and regulatory environments). Evidence that such profits exist could spur further research on this question, as well as inform implementors, participants, and regulators involved in sports betting, financial markets, and potentially other "wisdom of the crowds" mechanisms.