the Leicester story : The Black Fox Theory –  by Paul Leyland of Regulus Partners

the Leicester story : The Black Fox Theory – by Paul Leyland of Regulus Partners

Leicester City are Premier League Champions! Not a sentence that we thought we would be writing in a 2016 edition of The Winning Post. However, this result has now crept into practically every news story as a metaphor for ‘the impossible’ happening: the classic ‘Black Swan’ moment.

Since the league was wrapped up on Monday night after Tottenham’s now (in)famous battle with Chelsea, we have heard countless comments referring to the embarrassment of the bookies: the betting industry’s 5000/1 blunder. The Wall St Journal even went as far as accusing UK bookmakers of deliberately overpricing Leicester, in order to “rake in a little cash.” We’ve seen bookmakers putting their hands up and saying they got it wrong, a very few celebrating the success of a few lucky punters and others (more traditionally) state that they will never offer such prices again, on anything.

In a number of articles, Leicester’s amazing season has been referred to as a “black swan event,” a concept discussed and popularised by former trader and statistician Nassim Nicholas Taleb in his books “Fooled by Randomness” and “The Black Swan”. The Black Swan Theory refers to an event that is 1. Highly improbable, 2. Has a major effect and 3. Is inappropriately rationalised after the event with the benefit of hindsight. Whilst some may argue that bookmakers have succumbed to availability bias – ruled out the chances of Leicester (or indeed any team that looked like Leicester) from winning the league as there are no examples of anything similar occurring in recent history –  we believe that hindsight bias, is something that many commentators have been guilty of. Given their results and the pedigree of their players in the previous season; the acquisition of a manager who whilst a familiar name, was yet to win a top division title in his long managerial career; and a series of opponents that had spent their millions on high calibre talent, should bookmakers have anticipated this result? It’s hard to see how.

It’s worth noting another fallacy that the mainstream press has fallen guilty of, that of survivorship – the recognition of the dozens of customers still standing, those that have backed Leicester pre-season. And the lack of recognition of the vast majority that have fallen, those who placed their bets across the other 19 selections. This has led to the belief that the “punters beat the bookies,” which is, on pre-season stakes alone, a false one.

So what does this mean going forward? We expect punters to be searching for the next black swan, not just at the start of the Premier League, but indeed across other leagues and other sports. There will undoubtedly be as wide a spread of stakes on next year’s Premier League book as we have ever seen before. We may even see the effect in racing, as previously avoided 100/1 shots, may now be seen to be “in range” for some punters. There may however, be a negative impact on staking on the Premier League outright market, as the league has just to many, become tangibly more random, and less predictable, possibly reducing the number of higher staked bets on shorter price selections.

For businesses, Black Swan moments are a problem because the reverse engineering of randomness as an explainable set of circumstances can then go on to influence bookmakers’ decision making and (in both senses) risk management. The dangers of this are put rather elegantly by Taleb:
“They would take forecasting more seriously if it were pointed out to them that in Semitic languages the words for forecast and ‘prophecy’ are the same.”

On this basis, bookmakers should not be materially changing their policies on the back of the Leicester victory. Indeed, to do so risks two important issues: first, risk management becomes reactive and unbalanced, and therefore more volatile and easier to exploit; second, (some) bookmakers might enhance their reputation for stinginess, negatively impacting reputation and also market share.

Published with permission of the Author and Regulus: http://www.reguluspartners.com/home