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Information Efficiency in Financial and Betting Markets

Betting markets offer economists a fascinating case study of how information

efficiency operates in a market. They incorporate features highly appropriate to a
study of information efficiency, as each bet has a well-defined end point at which
value becomes certain. Using international examples, this is the first book to
and analyse the issue of information efficiency in financial and betting markets.
Part I is an extensive survey of the existing literature, while Part II presents a
of new readings by leading academics. Insights gained from betting interest a wide
community: governments, who like to tax betting; financial market analysts, who
bet on the financial markets themselves; and, lastly, mathematicians, who bring
their particular skills to the great mathematical puzzle of betting. All of these
want to read this topical survey of theory and practice in financial and betting

PROFESSOR L E IGHTON VAUGHAN WI L LIAMS is Professor of Economics and

Finance and Director of the Betting Research Unit at Nottingham Business
School, Nottingham Trent University.

A central issue in the analysis of markets is the degree to which they are
efficient. Although �efficiency� has a variety ofmeanings in different contexts,
a situation is sometimes termed �efficient� if it is not possible to increase the
well-being (utility) of any one person without reducing the utility of
another. This is usually referred to as Pareto efficiency. An implication
of Pareto efficiency is productive efficiency, a situation which exists when it
is not possible to increase the quantity produced of any one good without
reducing the quantity produced of another.

In the analysis of betting markets � and, indeed, financial markets more

generally � however, the examination of efficiency assumes an informational
dimension, the existence of which may well be related to that of
Pareto or productive efficiency, but the meaning of which is quite distinct.
It is this form of efficiency which is the subject of investigation in this
volume. This book traces the development of the idea of informationally
efficient markets, and identifies the various precise definitions and variations
of the concept extant in the literature on financial markets. The theoretical
background is clarified, and empirical tests of information efficiency are
reviewed and evaluated.

While most studies of information efficiency are conducted within the

framework of conventional financial markets, there are a number of
special features of betting markets which warrant particular attention
and make them of unique relevance to a study of market efficiency. In
particular, these markets not only possess many of the usual attributes of
financial markets � notably a large number of investors (or bettors) with
potential access to widely available rich information sets � but also the
important additional property that each asset (or bet) possesses a welldefined
end point at which its value becomes certain. This contrasts with
most financial markets, where the value of an asset in the present is
dependent both on the present value of future cash flows and also on
the uncertain price at which it can be sold at some future point in time.

The idea that the absence of a random walk by financial variables is

sufficient in itself to reject the existence of information efficiency in the
relevant financial markets was challenged by Fama. He produced
findings that larger than average daily stock price changes in his dataset
tended to be followed by larger than average daily price changes. However,
the signs of the successor changes appeared random. He concluded that
although this represented a contradiction of a random walk by these
variables, it did not contradict the existence of information efficiency in
the markets exhibiting these characteristics.

This distinction was developed by Fama, where he differentiated

between a random walk and a fair game, arguing that a fair game assumption
is sufficient for information efficiency, but that a fair game formulation
is not sufficient in itself to lead to a random walk. In so doing, he
echoed Alexander�s contention that assuming a �fair game� would
take one �well on the way to picturing the behaviour of speculative prices as
a randomwalk.

One of the tenets of capitalist economics is the principle of investment, the idea
of committing capital to make a profit. Traditional sources of investment have
included banks and building societies, stock markets and property. Profits from
these types of investment may come in two forms,to a greater or lesser extent,
depending on the nature of the investment. These are capital growth and income.
Capital growth occurs when the investment increases in value. One typical measure
of capital growth is the price of a share on a stock market. An investor may buy
some shares at �5 each. After a year, if they are worth �10, the investor has
doubled his capital. In contrast, if the price falls to �2.50, the value of the
capital has halved. Another mersure is the price of a house, which, like shares on
a stock market, can go up and down. How the value of an investment will change
over time will depend upon a whole host of influencing factors that operate within
any particular investment market. Naturally, any investor wants to avoid markets
that are falling, and concentrate on investments that wil return profits. Clearly,
not every investment will be a successful one. A successful investor is one who
can identify more winners than losers through an assessment of profitability and
analysis of risk.

Anothe obvious difference between gambling and investing concerns the period of
speculation in terns of time. Whereas traditional forms of investment discussed
earlier are generally made over weeks, months or years, the resolution of a bet on
the outcome of a game usually involves no more than a few hours or days at most.
Generally then, gambling might be considered to be high-risk, short-term
speculation, whereas traditional forms of investing are lower risk and longer
term. On the face of this assessment, it might seem rather imprudent to risk money
through sports betting, as the first of losing your capital is iust too high to
the speculator. Bettors, or punters, of course, rarely place only one bet, and the
size of any one stake will invariably be much smaller thanthe total capital a
smaller wagers, a punter can effectvely spread his exposure to risk, because it is
very unlikely that all the best will lose.

What Are Odds?

When a bet is placed between two parties on a specified event, the total amount
risked by both is usually agreed before the outcome of the event. The most bassic
of betsmight involve two friends, Paul and Mark, having a wager on the outcome of
an England football game. Paul might offer Mark �10 it England win, whilst Mark
will pay Paul �10 if England fail to win. Provieded that England has roughlya 50-
50 chance of winning, then this would be a fair wager. If, however, England were
playing Sam Marino, a realistic chance of an England win might be 95%. In this
case, Mark would have a distinct advantage over Paul, since the chnces of him
losing �10 are much less than those of him winning �10. Consequently, Paul and
Mark might agree to change the terms of the bet, with Paul paying Mark �10 if
England win, but Mark plaing Paul �200 if they do not. Since the chnces of Sam
Marino drawing or beating England are very small, Mark must risk a much large
sumin order to gain his potential reward form Paul, if Paul is to accept the bet.
To ensure that any bet between Paul and Mark is fair and acceptable to both, the
relative proportions of the amount risked by the two parties will be dependent
upon the expected probability of England winning their game. The amount risked or
wagered by each party is known as the stake.

Despite the relaxation of betting rules, with most Internet bookmakers now
allowing singles for the majority of football matches and other sporting events,
multiple bets remain fairly populars. Some may not be aware of the mathematic
working against them with these bets; others may be but remain impulsively
attracted to the lure of the bigger returns. Sometimes the only limit to the
number of selection included within a multiple bet is the bookmaker`s maximum
allowable payout on one bet. Stories abound of winning bets containing 15, 18, or
even 20 selections in an accumulator. A few may be true, although many may be put
out by the betting industry in an effort to maintain the punters` interest in the
multiple bet, a policy clearly advantageous to the bookmakers.

Perhaps the most important advantage of online fixed odds betting is the
availability of choice in the betting odds. In a busy high street, there might be
two or three firms available form which to choose. Provided youhave an available
betting account, there are literally dozens online. It is always in the punter`s
interest to secure the best possible price for his bet since the bookmarker`s odds
are weighted unfairly in their business. Eaca bookmarker, however, will take a
slightly different view regarding what he considers the correct price of an event
to be, which may vary quite considerably. There may even be rare occasions where
prices for an event vary so much that it becomes possible to back all possible
outcomes with different bookmakers and still ensure that a small profit is made
whatever the outcome of the event. Such betting opportunities are know as
arbitrage, a term again more familiar to spread bettors.

Punters differ in the methods they use to acquire a sports betting "knomledge".
Some like to adopt a more mathematical approach by using rating systems based on
past performance to predict ruture outcomes. This approach is explored in more
detail in the next chapter. Others spend hours each week poring over sports
journals and Internet sites to glean as much information as they can about the
weather, and team or player injuries and morale. Still others base their judgement
on a subjective feel for the forthcoming event, relying on an inkling or a hunch
about what may happen. And finally there are punters who simply pay others to do
the thinking for them, by subscribing to one or more sports advisory services.

There is no right or wrong approach to seeking a betting edge. Ultimately, the

best one is the one that works for you, one that returns a profit. However what
each approach has in common is a shared aim of finding "value" in the odds, where
the true chance of win is greater than than estimated by the bookmaker. Many
punters fail to appreciate the importance of value betting, preferring to
subscribe to the "back winners, not losers" school of gambling. Betting on
Liverpool at Anfield to beat Sunderland at 4/11, it might be argued, is surely
preferable to betting on Sunderland to beat Liverpool at 13/2, even if the bookie
has restricted Liverpool`s odds but been generouswith Sunderland`s. Liverpool,
simply, are too good, however poor the price.