Leicester City in the financial world

The fairytale elevation of Leicester City to championship of Premier League will hopefully ring implications far and wide; from FIFA to financial sponsors and of course people gambling on unknowable outcomes.

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Europe’s UEFA has long backed a system of tiers in national football (soccer) across the continent; allowing the best teams in each tier to be elevated to an upper tier while the worst performers in the upper tier get relegated.

This system has allowed a certain churn, and provided the right set of incentives for teams (or clubs in the European parlance) to improve. Leicester re-emerged from relegation into the Premier League as recently as 2014; and have now actually won the Premier League, England’s top tier of football.

FIFA can be inspired to reform

FIFA has a similar system, but one that favors incumbents rather a lot more. Instead of playing across continents, each national team only has to beat its nearest rivals inside the continent. For that reason, European teams feel cheated – many of those disqualified from the FIFA World Cup probably are better sides than the national teams from other continents – Asia and Africa come for particular criticism – that do make it to the World Cup. Hopefully, the experience of Leicester prompts FIFA to consider global tiers along the following lines:

  • A top tier that combines the great football nations of Europe along with strong South American teams such as Mexico, Argentina and Brazil
  • A second tier that pools Asian and African national teams along with second tier South American and European teams
  • A third tier that catches all other applicants including new nations

With enough charity matches between top tier teams over a two-year period, the qualification for World Cup can be determined similarly to how UEFA operates i.e. bottom 3 (or even 5) teams in the top tier get relegated; while the top 3 (or 5) teams in the second tier get promoted to the World Cup. Similarly, the bottom 3 or 5 teams in the second tier get relegated while the top 3 or 5 teams in the third tier get promoted.

With those changes, the format of the World Cup changes to only two groups (or at worst, 4 groups), vastly reducing the time it takes to complete the tournament from more than a month currently to less than 2 weeks. There are other benefits of this:

  1. FIFA is a notoriously corrupt organization, reducing tournament length automatically reduces the ‘one-time’ value of each World Cup event
  2. As FIFA would organize matches for top tier, second tier and third tier playoffs globally in the above format, more countries can host international matches – this vastly widens the global audience of football
  3. Instead of a ‘winner takes all’ lottery that the World Cup has now become, countries can work on building stronger national teams that can survive a two-year play-off program; in turn making the World Cup itself more interesting (currently many people including me prefer watching La Liga or EPL to national teams squaring off)

Financial sponsors

For almost 10 years, Barclays Bank had been sponsors of the English Premier League, which was renamed the Barclays Premier League. As fortunes in the financial industry have crumbled, Barclays has been steadily reducing its cost base which culminated in the decision two years ago to cut its title sponsorship. From next season (2016-17), the Premier League is simply called that without a title sponsor.

(It figures that the year Barclays cuts off the title sponsorship would be the one after that most fairytale of wins, but life is not fair especially for banks these days).

Financial sponsors have long questioned the benefits of major events that recur such as teams at the EPL or La Liga. In the case of Leicester, which is owned by Thailand’s King Power, sponsors have been various Asian names such as Tourism Thailand, Air Asia and Toyo Tires, along with other brands including DHL. These sponsors pretty much hit the lottery as LCFC stormed the championship; King Power was among the most searched names in the UK by the end of 2015 (thanks in part to the eponymous stadium that houses LCFC).

Asia, whose citizens have been starved of high quality football, has a particularly strong affiliation with EPL. Big teams such as Manchester United, Chelsea and Liverpool have truly strong fan bases across the continent, with the Man-U in particularly counting the region as its strongest area of growth. Exhibition matches have been well attended, especially in China where the domestic league now houses a veritable array of ex-Premier League and other top European players who have sometimes looked at their wages as preparation for retirement.

The fact remains though that Asia is very far away from housing a tournament that can rival the EPL in terms of quality and viewership. National politics along with infrastructure weakness disallow any such ambitions over the next few years; but one hopes eventually the region ends up housing a strong football league that brings together teams from Japan, Korea, China, Bangladesh and India.

Perils of financial models

Perhaps the funniest result of Leicester winning the EPL though is in finance and specifically the use of archaic financial models. Gambling companies stand to lose over £50 million thanks to them offering stunning odds (5000 to 1 which declined to 2000 to 1) for Leicester winning the EPL at the start of the season last year.

The general rule of betting is that a team’s supporters would almost inevitably bet on their teams; while very few people would take the other side of the bet (i.e. to “short” Leicester at 2000 to 1 or betting £2000 to make £1). For this reason, bets are aggregated across teams i.e. if you added up the money to be lost by all the other team supporters, it should roughly equal the money that will be made by the lottery winners who bet on Leicester.

In practice though, even that assumption of a zero sum game calls for portfolio optimization rather than mere linearity in betting. In other words, the inherent assumption behind those betting odds is that people bet on the same expected pay-off – so if 10 people bet £1 on Leicester winning at odds of 2000 to 1, the expected gain of £20,000 would be offset by a 1000 people who together bet the same amount on other teams such as Manchester United and Chelsea, but at far worse odds e.g. 2 to 1 for Chelsea and 5 to 1 for Arsenal etc. Only then would the ‘bookies’ or gambling operators expect to make money.

With stupendous odds such as 2000 to 1, the math simply falls away; and the whole betting pot becomes a directional one wherein the operator hope a team like Leicester does not pull off an upset win. Their confidence is based on historical data, which suggests that chances of such victories are few and far between to be considered statistically very unlikely.

You know, those ‘once in a century’ floods or stock collapses that no one expects; and yet happen with alarming regularity. That’s right – when one uses merely historical data, the propensity for wrong results increases exponentially over time. Whether it is the mispricing of volatility, the under-estimation of corporate defaults or the low probabilities assigned to certain types of disasters, the financial world is pretty much full of examples that mirror the experience of the poor bookies losing a fortune on the Leicester City outcome.

That makes me smile even more this morning.

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Categories: AT Top Writers, Chan Akya

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