Prediction Market Making Is Hard

I write about sports gambling around here more than I used to, because sports gambling has become pretty closely integrated with postmodern financial markets. Sometimes, when I write about sports gambling, I get emails from readers explaining that sportsbooks set their betting lines to balance bets on each side: A sportsbook sets the odds or point spread of a game so that it will pay the same amount of money regardless of which team wins. The book will collect, say, $100 of bets on the favorite and $50 of bets on the underdog, and it will set its odds to pay out $140 if the favorite wins and $140 if the underdog wins, keeping $10 — the “vig” — for itself in either case.

This is a popular view of sports betting, but it is wrong. It’s not entirely wrong: Sensible sportsbooks will manage risk and try to keep the action somewhat balanced. But in fact many sportsbooks regularly make directional bets on outcomes: They have some view of the likely result, and they set their odds to, in effect, bet on the more likely outcome.1 And then sometimes they lose money on a game, and other times they win money on a game, but if their models are good they win more than they lose and are more profitable than they would be if they always balanced bets exactly. Intuitively, the general public is systematically wrong — people tend to irrationally bet on their home teams, underdogs, etc. — and taking the other sides of those bets is generally profitable. The sportsbook might stay “close to home” (not too much risk either way), but it doesn’t have to be “flat” (no risk either way). It is not looking to take no risk; it’s looking to take the right risk.2