Do Bettors Categorize Bets?
In a frictionless market with rational investors, any price changes are due to changes in
fundamental values of the assets. On the other hand, if investors group assets into different
categories, then change in preference towards a category may cause changes in prices of assets
within that group. Thus, when investors categorize assets, asset prices within a group may move
together even when the fundamental values of these assets demonstrate no comovement among
them. Such categorization by investors could lead to an allocation of capital that is inefficient in
terms of risk and return.
Recent articles provide evidence consistent with the notion that investors categorize assets
along various dimensions. Pirinsky and Wang (2006) find that stock returns of companies
exhibit a strong degree of comovement with returns of other companies headquartered in the
same geo-graphical area. They also find, however, that underlying cash flows (measured as
earnings) exhibit negative comovement with cash flows of other local companies. Barberis,
Shleifer, and Wurgler (2005) focus on stocks that are added to the Standard & Poor’s 500 Index
and find that the returns on the newly added stocks co-move more with returns on other S&P 500
stocks than with returns on stocks that are not part of the index. Besides geographic location or
membership in an index, another dimension by which investors appear to categorize investments
is stock-price magnitude (Green and Hwang (2008)).
A limitation of the Pirinsky and Wang (2006) study is that assets under consideration are
multi-period assets; these assets’ returns may co-move in a given period of time in anticipation
of comovement in earnings in any subsequent periods, without any comovement in
contemporaneous earnings. Also, studies of comovement around index additions and stock splits
must be cautious of changes in underlying fundamentals surrounding the events of interest:
while fundamental values should not change surrounding either type of event, some evidence
suggests that market participants’ perceptions of future cash flows are influenced by these events
(Denis et al. (2003), Kalay and Kronlund (2009)).
The market in which we conduct our study is not characterized by these same limitations or
precautions. Each asset (i.e., each sports bet) in the college football betting market has a life of
only one period, thereby eliminating the possibility that comovement in current prices is caused
by comovement in any cash flows other than contemporaneous ones. Another useful feature of
this market is that a sports bet’s value is unambiguously realized at the instant a game ends – the
cash flow associated with that bet is easy to measure. Another advantage of our marketplace is
that required rates of return are nearly constant across all wagers in our entire sample, because
risk is the same across all wagers. Therefore, fundamental value of a wager – defined as
expected future cash flow discounted at an appropriate required rate of return – is likely to
change only if the underlying cash flow changes. This unambiguous relationship, together with
the fact that we can clearly measure the single relevant cash flow for each wager, make our
market an advantageous venue in which to test whether comovement in prices is driven by
comovement in fundamental values.
Bettors may very well be constrained by attention scarcity due to the number of games
played each week. In addition, the assets’ short lifespans of approximately one week require
bettors to update their information sets every week, complicating their task of processing
information. In order to simplify the task and the choices involved, bettors may categorize
games based on teams involved in each game.
We are interested in the possibility that bettors separate games into different categories
based upon the types of teams involved in each contest: (1) Games involving two majorconference teams and games involving at least one non-major-conference team and (2)
Conference games and non-conference games. We explore whether percent change in point
spread for a game (our market’s analog to percent change in prices in financial markets) is
influenced more by percent changes in point spreads for other same-category games or by
percent changes in point spreads for the complement set of games. We also examine whether
any relationships exist among underlying cash flows within and/or across different categories of
games.
We test for comovement consistent with categorization, using bivariate regressions, and find
that point spreads for a particular category of games co-move with point spreads for other similar
games. We further find that the underlying cash flows among similar games do not co-move.
Traditional finance theory suggests that if we observe comovement in spreads among a set of
games, we should expect to see comovement in underlying cash flows for those games. Our
findings that spreads co-move (in the same direction) among similar games, while the underlying
cash flows appear to co-move in opposite directions, together are consistent with the presence of
“style bettors” in the college football wagering market.
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