The Relationship between Sports Betting and Investing
What happens in Vegas, doesn’t stay in Vegas; it makes its way to Wall Street. New research shows that gamblers who profit from football betting invest more heavily in lottery-like stocks.
Behavioral finance is the study of human behavior and how that behavior leads to investment errors, including the mispricing of assets. Behavioral theories propose that psychological influences and biases can affect the financial behaviors of investors and financial practitioners alike. In 2017, one of the “fathers” of the field of behavioral finance, Richard Thaler, won a Nobel Prize in Economics for his contributions. Among Thaler’s contributions, from his 1990 study, co-authored with Eric Johnson, “Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice was the finding that following prior gains individual investors tend to exhibit “house money” behavior – becoming more risk-seeking in their investment allocations. Conversely, following prior losses, investors tend to exhibit “break-even” behavior, becoming more risk-seeking in selecting their investment opportunities. These behaviors form the basis for prospect theory (how individuals assess their loss and gain perspectives in an asymmetric manner).
Justin Cox, Adam Schwartz, and Robert Van Ness contribute to the behavioral finance literature with their study, Does what happen [sic] in Vegas stay in Vegas? Football gambling and stock market activity, which was published in the October 2020 issue of the Journal of Finance and Economics. They began by noting that prior research had established that the propensity to gamble and invest are positively correlated, conditional on socioeconomic clienteles, and that following the opening of nearby casinos, local investors significantly increase the amount of idiosyncratic risk exposure in their portfolios, which indicates higher demand for lottery-like securities.
Cox, Schwartz, and Van Ness posited that the Thaler and Johnson’s house money and break-even behaviors are consistent with how gambling sentiment influences trading behavior in the stock market, particularly for lottery-like stocks (those with very poor average returns but with a small probability of lottery-like winning). Lottery-like stocks, which tend to have low average returns, high return volatility, and high share turnover, include stocks in bankruptcy, penny stocks, and small growth stocks with low profitability and high investment. For example, gambling sentiment from football betting winnings potentially leads to a positive emotion and excitement among investors, causing them to become less risk-averse and more confident in making stock selections.