The Fama Bracket Challenge (Free $!)

  In 2012, Eugene Fama won a share of the Nobel Prize in Economic Sciences for his work related to the Efficient Market Hypothesis.  Fama, who probably wouldn't be fun to take barhopping, argued that stock prices reflect all knowable information about the company and are, therefore, "efficient".  Thus, investors who meticulously research companies' financial reports are wasting their time.  This view is something Eugene and I have in common.  And because I don't waste my time researching which companies' stock to buy, I have extra free time to write borderline pointless articles like this one! 

So, what does Eugene Fama have to say about the great game of basketball?  In his Nobel Prize bio, he stated that he "played basketball poorly".  Hey, that's another thing Eugene and I have in common!  Maybe we could go barhopping after all.  And speaking of hopping, Eugene claims to have placed second at the state high school track meet in high jump despite a 5-foot-8 frame.  Okay, Uncle Rico. 

The logic of the efficient market hypothesis is based on the more general concept of the wisdom of the crowd--when lots of people express their informed opinion, the average of these opinions is shockingly accurate.  I have tested this concept in my own classes and the results are striking.  For example, I ask all students in my freshmen seminar classes to guess the weight of my dog, Cinco, who happens to be a not-so-svelte 76.3 pounds.  While individual guesses varied wildly, the average guess across these two classes was 75.7 pounds and only three students provided a guess that was more accurate than the average guess of all students.(1)  The larger the population of "guessers", the more accurate we would expect the average guess to become.

This same logic can be applied to the stock market.  At the time of writing, Apple is trading at a share price of $213.20.  Some believe this price is too low (Apple is undervalued, good to buy) and others believe it is overpriced (a good short-sell opportunity).  The current price serves to perfectly balance all investor sentiment.  Through buying and selling, millions of investors assert their opinion on the price of Apple.  All of the data analysis that these researchers did is thusly already reflected in Apple's price.  We expect Apple's current price to be the most accurate predictor of Apple's future price.(2)

  If Fama is right and markets really are "efficient", all companies are (nearly) equally sound investments.(3)  If Apple trades for $213.20 and General Motors is priced at $48.77, these two firms are equally likely to be good investments today.  Thusly, investors are wise to buy as many companies' stock as possible--this can be most easily achieved by investing in index funds.  A fully diversified index fund is destined to earn the same return as the average of all stocks, but does so with very low investment fees and relatively low risk.  Embracing index funds is, in my opinion, one of the core principles of financial planning.

Creating the Fama Bracket

  Eugene constructs a March Madness bracket in the same fashion that he builds a portfolio, letting market interactions serve as a guide.  Based on Fama's insights, there's no need to watch game tape and analyze box scores; instead, find a way to stand on the shoulders of others that have already done so!  Gambling markets work pretty well for his purposes.  About $3 billion will be bet on the Men's NCAA tournament this year (source), more than enough for the wisdom of the crowds to do its thing.(4)  Gambling operators like FanDuel set initial gambling odds and frequently make adjustments based on news (e.g. player injuries) and the wagering behavior of gamblers.  If a team is an unexpectedly popular pick among gambler's, the odds will be adjusted to discourage gamblers to make additional bets on the team and, likewise, the odds will be adjusted on the team's opponents to encourage bets.  At any given moment, the gambling odds for a team are roughly balanced so that every team is an equally good (er... bad) pick.

  The details here get messy, but we can ascertain the probability of a team winning each game in the NCAA tournament with relative ease.  For example, eight-seed Mississippi State University (Hail State!) has as 53.33% chance of beating Baylor University in round one, based on gambling odds provided by FanDuel Sportsbook.  Using these odds as a guide, the following teams have the best chance of hoisting the Naismith Trophy.  Duke (gross) is the odds-on favorite.

Ten Most Likely Winners, Based on Gambling Odds

The $150 FreeFinanceBook.com March Madness Challenge

Rules:

1. No purchase necessary.

2. Everyone is allowed to enter one bracket.

3. The overall winner will receive $100.  Second place earns $30 and third place $20.   Prizes will be paid via Venmo or similar means.  Funds come out of my pocket (you're welcome).  

4. We will ignore CBS's tie breaker rules.  In the case of ties, money will be shared evenly.  For example, if two players tie for third place, each will receive $10.

5. One point is awarded for each correct round 1 pick, two points for round 2, three points for round 3, etc.

6. Competitors must complete and submit their brackets via the link below.  There is a firm deadline of 12:00 ET, March 20th.

7. We will generally follow the rules posted by CBS, which can be found here. 

***Click Here to Make Your Picks!***

Footnotes

1. This in-class assignment was based on this super neat podcast episode.

2.  With a current price of $213.20 and an average historical return of 10% for all stocks, we could guess that Apple's price will be about $234.52 in ten years (ignoring dividends).  Any significant deviation from this expected future prices is a result of something that investor's currently cannot know, Fama would argue.

3. Risk also plays a role.  Because investors need to be compensated for risk, we can expect that riskier firms (e.g. small caps) will slightly outpace safer, more established, corporations.

4. The average loss on a sports gambling bet is about 7%.  Thus, gamblers can expect to lose about $210 million betting on the tournament.  No judgement here... you can lose money doing something and still be happy.  I lose money to Netflix every month!  But, keep in mind that sports gambling is illegal in many states, including my home state of Georgia.  If you find a way to bet on the outcome of March Madness games in Georgia, you are probably breaking the law.

5. ...and it's subject to change.  As gambling odds are adjusted, so too will Fama's bracket.  Up until noon E.T. on March 20th, changes can be made to Fama's bracket.