Tuesday, November 16, 2004

Salary Cap Football and Ratio analysis: what they teach us about markets

I am in a fantasy Salary Cap Football League through Yahoo. It is really fun and keeps me interested in all the teams.

But as much as I like picking the team, I think it is almost as fun to see how the market operates. For instance, earlier today I was researching various ratios that Yahoo provides for the players. These ratios include points/$. Since it is a salary cap league (example of hard rationing), this is trying to measure how much you get back (presuming the past repeats itself) for a dollar invested--sort in the spirit of a profitability index). I noticed that the Giants QB Kurt Warner was the highest ranked QB when on this scale. "Mmm...I wonder why, he is having a decent year, but not that great." So I look at what he is selling for: his value had dropped significantly.

Something must have happened. A few hours later I heard the sports news on the radio and find out that Warner had been benched and that Eli Manning was named this week's starter.

What does this have to do with financial markets? A great deal! First notice that market seems to be largely semi-strong form efficient. By the time I had heard about the benching, the price had already reacted.

Secondly, notice how the markets are forward looking. People will not pay for past performance. Ratios however, are historically based. This explains some of the large variation on ratios which are at least in part based on historical accounting numbers and explains why we can not blindly make decisions based off ratio analysis.

Now I must admit not only do I teach finance but also I am currently ristening to The Wisdom of Crowds by James Surowiecki, so I am a bit predisposed to see signs of market working. BTW the book is awesome so far! Many good examples for class!!!

BTW I have been really lucky in the league and am doing pretty well (check my stats and team out, my name is PlayingGM).


Anonymous said...

Jim, you appear to be doing very well in the league. What does that have to say about market efficiency? Shouldn't everyone be about the same since we all have the same information.

I know I play in a Yahoo salary cap fantasy league and currently have almost 200 points fewer than you do.

Luck? Is that like the Buffett story on monkeys? Or do you have inside information? I remember you saying you had Tom Donahoe speak to your class once. Maybe he is giving you tips.

Keep up the good job on the blog. While I liked the newsletter format better, I have to admit this is growing on me.


FinanceProfessor said...

LOL...no Donahoe is not helping me. I would say I am just lucky...But you are correct that there should be little advantage in player picking.

Intellectually what is more troubling for me is the "pick-em" league I am also in. In this league you get points for accurately prediciting who will win games. So you just pick who you think will win the game.

I have to ask myself why I am in the league. If I truly believed in market efficiency shouldn't I just be picking the favorite (you do not have to pick against the spread) in a form of indexing for football. But alas, I get enjoyment form picking teams. Which is like one behavorial explanation of why people trade so much---because it is fun!

Now when I have money on the line (i.e. in the stock market) I do index, so maybe fun matters, but only so much.