Another great read.
economic theory determines that where there is a free
market in which goods and services are freely tradable
the market will generally determine a market price that
is "efficient". On modern betting exchanges the same
forces exist. The betting exchange is simply a meeting
of minds and opinions on which prices are formed. There
is no obligation to accept the offered price and users
are free to offer or accept whatever price they wish.
This should lead to efficiency, But the question has to
be, "Is the market efficient?"
much unresolved debate about who follows who on the
betting exchanges. Do bookmakers lead the betting
exchange price or do the betting exchanges lead the
bookmakers? What forces shape and determine market
prices is something that I have spent a lot of time
studying to the point where I can determine with a much
higher degree of accuracy than chance would suggest
which direction odds are likely to move on a macro and
broad basis. Not only which way but why and how. Some
markets and situations are easy than others but
rationale lies behind all. This discussion however is on
the general efficiency in the market. In my research I
needed to visit both ends of the spectrum to unifying
macro and general prices and movements. The conclusion
that I reached was that, in general, market is
Description of graph
graph shown below there are three lines. Implied
probability, actual and inclusive of commission.
Implied probability is achieved by simply working
out the implied probability of an event derived from the
odds offered. Odds of 2.00 would convert to an implied
probability of 50%. The calculation being 1/2.00 = 0.50
or P(e) of 50%. When exchange users offer a price of
2.00 they are saying the event will happen once every
two occasions it occurs.
probability is derived from historic data taken from
the exchange, in this case Betfair. All the odds that
are offered are listed and a sum of all winners at those
prices is counted and divided by a count of the times
that the odds have occurred. For example if the odds of
2.00 received 5,000 winners and occurred 10,000 times we
would calculate the actual probability as 5,000/10,000
or .50 representing 50%. 50% of the time odds of 2.00
produced a winner. This historical data represents the
key data at all times in the market. I have not taken a
snapshot of the market at any one point or used the SP
or a default time to capture the odds. This is all odds
offered at all times in the market. Incidentally, I have
also studied when the market is most efficient, but
that's another story.
all winners on Betfair have to pay a commission so the
final line is the probability adjusted for the
effect that commission has on odds. The general
effect is to skew the odds offered against the users.
This is where the exchange method of betting is clever.
Because the user can back or lay many selections from
one event and only pay commission on the winning outcome
the user can mix and match risk in one event. This is
because there are no commission costs on a loss, only a
win and no transaction costs. This allows the user to
take many positions and to even hedge out open positions
before, during or at any point up to the finish of the
event. If you could perform such feats on the stock
market I am sure volumes would sky rocket.
extensive data from many markets but picked on horse
racing. This was simply because of the volume. At the
time of writing this document in early 2005 matched bets
on horse racing on Betfair in the UK is running at
around ?500m a month. A sufficiently large sample
set to use. The data shown here was taken from the
November horse racing market. The graph only shows data
for prices between 1.01 and 2.00.
graph you can see that the implied probability is a nice
curve, this is on the basis that the implied probability
is perfect. For the underlying market you would expect
to see a similar but bumpy curve on the basis of small
levels of volatility in the market, in pricing and
because of lack of equipartition. If I combined all the
data I would expect the line would likely be smoother.
the poorer odds available due to the effect of
commission, you can see that the inclusive of commission
line is higher than the implied line. Because the market
is generally efficient and priced "tightly" the
commission pushes you beyond any immediate value.
interesting line however is that of the actual
occurrence of these events. You can see the implied line
bisects the actual line on many occasions but more or
less tracks it. The conclusion being that the market is
pretty efficient at assessing accurate implied
probabilities simply through the pricing mechanism
available in the market place. If you pay 2.00 in
digital odds (You accept odds with a 50% implied
probability) the selection will, over time, come in
around 50% of the time. The total average variance
against all odds versus implied probability was small. A
variation of 0.271%. This means that on average the
difference between the odds you are seeing on the screen
and the actually chance of the event happening is tiny.
Much less than the commision you are likely to pay. On
Betfair the lowest commision you can pay is 2%. Because
it is paid on winnings only, this means the lowest
effective rate is 1% (As you will win 50% of the time on
average assuming the odds are evenly distributed). This
leaves you, even if you qualified for the lowest rate of
commision, with a net deficit of -0.729% on average,
overall, over time.
the odd variances in at the short and long end of most
markets I have studied. Suggesting the implied
probabilities are not correct, fairy consistently. This
may be due to over zealous "grabbing" of "free" money or
people closing out their positions. It is likely to be
caused by people backing low or laying high earlier than
the true probability.
strategy is to make money by backing or laying something
on the basis of "value" the statistics indicate that if
you continue to do this over a long period of time you
will likely only match the long term implied
probability. Furthermore because of commission you will
likely lose ; the only winner here is the service
provider. Therefore the edge in the market does not
belong to either side of the market, but to the betting
exchange in the form of commission.
You have to
conclude that in general the betting exchanges offer
much better prices for users using broad backing or
laying techniques. This occurs through the efficiency of
the market as demonstrated by the fact that, in general,
the implied probability matches the true probability of
an event occurring. However, believing that that better
price creates opportunity for gain by creating value is
a false assumption and should be avoid.
would appear to be a beautiful demonstration of the
efficiency of a freely tradable market. Of course if the
government decides to tax it unfairly then the
efficiency will be ruined.
Tax is not
payable on gambling winnings. Why?
this is based on the fact that betting markets are
efficient as detailed in this document. At the end of
the day if the market is efficient and the provider of
the betting service is overround or taking a commision,
this effectively pushes the punter into an inevitable
loss making situation in aggregate to the benefit of the
provider of the gambling service. While there may be
pockets of people that have beaten the market these will
be small and to the far right of the bell curve, the
majority will lose. To only tax the individuals that win
is folly. Also to tax individuals for gambling income
would mean giving relief for losses and expenses. As we
know, the aggregate of gamblers lose in total and this
would mean the tax man providing relief for all. This is
not a sensible situation at all from a tax collection
perspective. Because the provider of the gambling
services will almost certainly make a profit at the
gamblers expense it makes better sense to enforce tax
collection at this point where winning and taxable
income is ensured.
about horses and horseless carriages
help but write about the bizarre debate raging about
betting exchanges and the incumbent industry leading
bookmakers. More specifically why betting exchanges and
their clients should be treated in a different fashion
to the existing market. To demonstrate my argument a
carriages (cars) were a neat invention. However despite
the revolution that was going on they did not meet with
universal approval. Horseless carriages were cumbersome
contraptions and had been powered by steam engines as
far back as the late 18th Century. They met great public
resistance based upon two key isssues.
try to compete, stagecoach owners decided to cling to
the existing state of affairs rather than identify that
an irrevocable shift had occurred in transportation and
opponents to the horseless carriage succeeded in
harassing experimenters and lobbying authorities and
laws were passed forbidding the use of steam engines on
roads. In England, stupidity triumphed when Parliament
passed the Locomotive on Highways Act in 1865. Popularly
referred to as the "Red Flag Law," it stipulated that
all self-propelled vehicles on public highways be
limited to a maximum speed of four miles per hour and be
preceded by a man on foot carrying a red flag to warn
oncoming horse-drawn vehicles. Although the law was
amended in 1878, it still retained the speed limit and
required two people to operate the vehicle and a third
to go ahead at danger spots, like intersections, and
give a warning. After eventually seeing sense the law
was repealed in 1896 but not before other, more
enterprising, countries had taken the advantage. Such
laws were unknown in the United States and the rest as
they say, is history.
belief and understanding of the free market are two
diametrically opposed forces certainly where vested
interests are at play. Suffice to say that the UK and
its attitude put paid, or at best, delayed the adoption
one of the most important innovations of the recent
times. This in turn delayed increased productivity and
commerce. The government also lost out on the basis of
the fact that failure to spot his shift meant new
commerce did not generate new profits which did not
generate tax income.
forces could not be resisted and eventually the UK lost
initiative, supressed economic developement but
eventually embraced the horseless carriage when it was
obvious that it was actually a good idea.
exchanges the UK has become a global leader in this new
and exiting industry. Exchanges are a new paradigm and
demonstrate destructive capitalism at its best. Without
these break points in economic development we would not
be using computers for fear of decimation of the pen and
paper would we? Inevitably these break points cause
short term distruption to business and tax revenues as
the market adjusts to the new state of affairs. By
over-regulating or attempting to punish the success of
exchanges it could be possible to de-rail this progress.
Progress that could lead global dominance by the UK in a
new industry and one that could generate significant
opportunities for UK PLC.
best efforts I don't see many members of parliament
currently using horses in London. But they do appear to
use horseless carriages a lot. If they want to see the
country prosper and develop they should learn to embrace
and encourage new ventures rather than penalise them.
Failure to do so should see all members of parliament
adopt a drive to abandon the horseless carriage and move
back to horses, to drop computers and adopt the pen and
paper. If you fail to allow those things to progress and
shape the world as they have done in the past you will
fail to let the innovations of today shape tommorrow.
Being an Economist myself, i have to say this was an enjoyable read. Very interesting.