Of Probability and Presidents

Updated: May 17

Cricket often produces riveting five-day games, but in early November the US delivered its own epic struggle. I refer of course to the presidential election which, at the time of writing, had been declared as having been won by Joe Biden. I appreciate that the ramifications of the election result are serious, but for observers of betting markets and connoisseurs of probability theory, the days leading up to and following 3 November were a lot of fun.

"Investing and so-called skill betting are driven by the same forces"

Betting odds, 2-to-1 for example, can be expressed as an implied probability of a particular outcome of an event – to convert 2-to-1 to a probability you add 1 to the first number and take the reciprocal, i.e. 1/3 or 33%. This probability can be thought of as the ‘price’ of the outcome in question. The eventual ‘price’ of the outcome will either be 100% or 0% – the outcome either happens or it does not – and in the lead up to the outcome being known, the ‘price’ will fluctuate between 0% and 100%.

Charts of these ‘prices’ over time can be constructed in the same way that prices of investments can. Indeed, from a purely mathematical perspective, there is no difference in the nature of the price movement of an investment and that of the ‘price’ movement of an event relating to, say, sport or politics. Both are examples of Markov Chains, series of numbers that contain both randomness and pattern.

Yes, there are differences. Prices of investments do not tend to 0 or 1 – 0% or 100% – in the way betting market implied probabilities do. But this is a technical not a fundamental difference. Both betting markets and investment markets involve uncertainty. Both are expressions of an amalgamation of the views of many millions of people. Both involve trading on exchanges. This is what makes them identical mathematically and is the reason, unless you had knowledge of price histories, you would not be able to distinguish between a price chart of, say, Amazon and the price chart of a Biden win.

Many may find it hard to accept that investing and so-called skill betting are driven by the same forces. It is hard to think purely mathematically, banishing all thoughts of whether the underlying exchange is a stock market or a betting market, or whether the event relates to Unilever or the 2pm at Haydock Park.

More to the point, it is not in the interests of the mainstream investment industry to advertise its similarities with gambling. The image of a fund manager as portrayed by the industry is of a cerebral, respectable, professional, qualified individual, not the fly-by-night, seat-of-the pants operator that is the stereotypical gambler.

I should add that my own albeit limited experience with professional sports bettors is that they are more thoughtful and humbler than many of the fund managers I have had dealings with over the years. That is not to say humble fund managers do not exist. They do, and often they are the more successful, whether because they are acutely aware of how difficult it is to be a successful investor.

I do not bet on sports or politics, but I enjoy observing the betting markets and on the day of the election I did mention to two friends that I thought the odds on a Biden win were too long – an implied probability of 60% – and that a successful bet could yield a gross return of 67%.

My argument was that I thought betting markets were being driven by a fear of pollsters – most of whom were predicting a comfortable Biden win – getting it wrong yet again. I had noted that many polling companies had said they had fixed their vulnerabilities to the so-called social desirability bias – aka shy Trump voters – that had plagued them four years earlier.

I woke at 4am UK time on 4 November to find that Trump’s implied probability of winning had risen to 80% from 30% the day before. My heart sank – how could I have been so stupid to think I had some sort of edge in a market on which billions had been wagered?

Although the result has yet to formally declared, I am relieved that it looks like I will be right. That said, if I am right, it will not be down to ‘deserved success’ but ‘dumb luck’, a strategy, I should add, that tends not to have longevity.

Five-day cricket matches often end in a draw. Americans may find such an outcome deeply unsatisfying, but at least cricket matches do not drag on longer than they should.

Published in What Investment

The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.

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