The Over-Under Conundrum

Let’s say that with only 10 seconds left, the Golden State Warriors, down two, just missed a shot. The probability of a win is less than 10%, and the betting odds should have shifted to reflect that near certainty. But they don’t.

“What shows up in the betting markets is that people treat baskets as too similar over the course of the game. They overreact to information that’s not very important—early baskets—and underreact to strong signals at the end,” says Assistant Professor Eben Lazarus.

This misinterpretation of new data holds true from sports betting to financial markets, according to a paper published in the Quarterly Journal of Economics by Lazarus, Associate Professor Ned Augenblick, and Michael Thaler of University College, London. 

Building on research

The study builds on decades of behavioral psychology and economics research about how people update beliefs given new information and connects to studies looking at how financial markets sometimes overreact and underreact to news.

Researchers theorized that most of the time people don’t have enough information to accurately judge how important information is, so they tend to default to a middle ground.

“In cases where it’s easy to figure out which direction to update your beliefs but not quite how much you should update, people will tend to treat all ‘good’ information somewhat similarly,” Lazarus says. “Given this difficulty, you’re going to see people overreacting to news that’s fairly weak and underreacting to news that should move you close to certainty.”

Experimental evidence

In one experiment, researchers recruited 500 fans and presented them with a simulated basketball game with 2:40 left in each quarter. After watching four possessions, participants had to predict the probability of each team winning (and could earn $50 based on their accuracy). Researchers established “correct” win probabilities using data from the website inpredictable.com. 

While participants understood that late-game baskets were more important, they still gave early baskets 60% more importance than warranted—and underweighted fourth-quarter baskets by 33%.

Lazarus and his co-authors found the same pattern after analyzing over 5 million betting transactions across 260,000 basketball, soccer, football, and ice hockey games on the sports prediction market Betfair as well as option price quotes on the Chicago Board Options Exchange from 1996 to 2018.

While the research explains some puzzling patterns in how people and markets respond to news, Lazarus cautions that being aware of them does not remove all risk.

Still, the findings suggest that it’s wise to pay attention to how much weight to give different pieces of information, even in situations that are far more ambiguous.