Gambling and "the Market"

Big controversy in the NBA as one of their refs, Tim Donaghy is accused of fixing games, and no that doesn't mean helping to bring back the mid-range jumper. He's accused of working with Mafia types to skew the the points scored in games, specifically effecting the over/under line.

But what I find more interesting is that he was able to pull this off. According to ESPN,

research into Donaghy's last two seasons supports Bell's claims. In the 66 games Donaghy refereed in the 2005-06 season, the two teams in his games combined to score an average of 196.8 points. The average over/under, according to BoDog.com, was 186.6, a difference of almost 10 points.

In 2006-07, Donaghy refereed 73 games. In those contests, the two teams combined to score 201.37 points and the average over/under was 187.9 points, a difference of more than 13 points per game.

"Vegas is too good for that to happen," Bell said. "The standard range should be somewhere around five or six, maybe. Not 10 or 13."

Mr Bell is right, Vegas is too good for that. But what's more interesting is that Vegas was not too good to price this information into the spreads of games worked by Mr Donaghy. After all, the spreads are public, and are viewable by millions of people, not just gamblers. So are the referee schedules. Again, from the article,

At the start of the 2007 calendar year, Bell said, there were 10 straight games in which Donaghy was part of the officiating crew and the point spread moved a point and a half or more before tip-off, indicating big money had been wagered on the game. In those 10 contests, according to Bell, the big money won all 10 times.

So, clearly, someone was getting the benefit, but not the whole market. The market failed to notice that for 10 straight games, and for two seasons, games refereed by Mr Donaghy hit the over by a large margin. With all information publicly available, millions of dollars wagered, and tens of millions of observers this free market should have bid up the over/under line to reflect the "Donaghy Effect." Markets are not supposed to leave "cash on the table" or unexploited profit opportunity. Yet the market missed this. Badly.

Why?

Because, despite what textbooks and Cliff Note versions of Adam Smith tell us, markets are not perfectly efficient. They do leave "cash on the table" and miss significant events and signals. This is not a dig on "the Market" rather a reality check. The Market is the best thing going, but its not perfect, not by a long way. Some folks treat it like it is and get confused when its not. Take the old joke about an old economist and a young economist walking down the sidewalk. The young economist says, "look, a $100 dollar bill on the ground" and goes to pick it up. The old economist stops him and says, "its not real, if it were, someone would have picked it up by now." If economic theory as commonly stated were right, the market should have recognized the number of overs hit when Donaghy refereed, I mean, it had two years to find this information. Even more telling, figuring out the "Donaghy Effect" did not require any inside information, or archaic math equations or intense skulduggery. It was decidedly straight forward.

This is why stock pickers can beat the market, this is why entrepreneurs can succeed, and why people make profits. Its not that the "The" Market is perfect, its that the market is flawed. It's the "Free" Market that allows people to succeed in "The" Market. Remember this next time someone tells you that things are "priced into the stock" or whatever. That, and sometimes simpler is better.

As for the NBA. Maybe it should fully embrace gambling. Rather than spend all that time and money to monitor players and refs, let the market of gamblers inform the NBA of what's expected. When reality deviates from what that market expects, points, fouls, wins, player stats, etc then that should signal that something may be up. Focus on what millions of participants, with money on the line, have calculated. It's a bigger and better model than anything created on the NBA's budget of time and money. Had the NBA done that, they would have noticed the "Donaghy Effect" long before an informant tipped off the FBI.

To come full circle markets work. You just have to understand what that means.