A random cat down Wall Street

A cat just won the Montreal Gazette's professional football pool. And I'm not being catty when I call it a triumph for expertise. Not, perhaps, for the 11 broadcasters, sportswriters and former pro players the Gazette pitted against editor Lucinda Chodan's brown tabby Miss Kallie. They seem not to know one important fact: "the line" itself is a triumph of expert opinion and design, a classic case of the spontaneous order created by markets.

Thanks to a mystery novel by former NFL quarterback Fran Tarkenton, I know bookies are not gamblers. They are entrepreneurial middlemen who buy and sell risk without taking it. And as supermarkets do with apples, they try to acquire just enough risk from suppliers to satisfy demand. They don't care how likely Ol' Paint is to win a race or even whether he does. They only care that whatever happens, they collect enough from the gamblers who lost to pay off those who won, plus a small fee for themselves.

So they start with a rough guess as to how likely Ol' Paint and the others are to win, then adjust the odds up or down on new bets as the wagers pile up so that when the starter's gun fires they've given average odds of three-to-one on a horse if there's one dollar bet on him for every three dollars bet against him, four-to-one if there's $1 bet on him for every four dollars bet against, and so on. Then, no matter which horse wins, they transfer the money from the human losers to the human winners, minus their cut. In races with a complex payout based on 1st, 2nd and 3rd place, the math is more complicated but the principle is not.

Nor is it in the football "line." One wrinkle there is that instead of offering variable odds that Great Blue will defeat Big Red, bookies offer even money bets that Great Blue will win but by a variable margin, which they adjust up or down to keep the totals bet on each side equal. But again, the bookies aren't telling you what they think. They're calculating what everybody else thinks.

Wait. Doesn't that mean you can look for some systematic flaw in the bettors' assessment that lets you consistently beat the line? No. Hordes of fools gamble; what else could explain roulette? But lots of smart people bet too, and the odds already reflect their best guess as to what the dumb ones are doing wrong. The result is not perfect, nor given life's unpredictability could it be. Even when no horse is more likely to win than not, some horse must win. But the odds incorporate the best guesses of the smartest people as to the probable outcome based on the best information actually available. And you can't outsmart everyone.

Worse, any systematic strategy for doing so will go systematically wrong. That's why the cat had the best strategy, namely randomly sniffing bits of paper with team names written on them (or, if it wouldn't sniff, batting them once they'd been crumpled up). Her 101 wins, 82 losses and nine ties, or .552, was slightly lucky. But a certain amount of luck is itself probable; thus five humans and the cat beat the odds at the Gazette and six humans did not.

Why should you care? Well, if you don't already know the joke that horse sense is what keeps horses from betting on humans, it may save you a few dollars. Knowing it's also true of stock prices may save you a lot more (see Burton Malkiel's A Random Walk Down Wall Street). Of course you can occasionally get lucky, either in a random stock pick or by finding some relevant piece of information not yet generally known. How else would stock prices come to reflect all that can in principle be known? But you should still buy and hold broad-based mutual funds because, as a rule, by the time you've realized a certain razor shaves so close it obliges you to fend off half-clad females, so have lots of other guys.

Cats' eyes can even help us peer into the future. The Pentagon recently got in trouble over a scheme for futures contracts on real coups and assassinations. But while I would have bet on bad publicity if it got out that John Poindexter was letting people gamble on Yasser Arafat's head catching fire, the idea is sound. For instance, on global warming I'd trust the new weather futures on the Chicago Mercantile Exchange more than a David Suzuki prediction. And I'd say watch the Internet site where you can buy and sell contracts on such matters as the re-election of George Bush (lookin' good) or the capture of Osama bin Laden.

Finally, insurance premiums are a great way to judge real risk because they too combine real consequences for guessing well or badly with a widely cast net. For instance, when you buy life insurance you (or a loved one) are betting you'll die soon. Yet the middlemen who must weigh expert opinion precisely to make money won't ask if you own a gun.

Any cat can tell you why.

[First published in the Ottawa Citizen]

ColumnsJohn Robson