The Theoretical Financialization of Betting Exchanges as an Investible Asset Class

Abstract

The concept and implementation of prediction markets and more specifically exchange betting have existed for the past two decades. From the consumer’s perspective, there are many advantages to exchange betting markets as compared to the traditional sportsbook business model. However, exchange betting models still face regulatory, social, and technical headwinds.

This paper analyzes the viability of the theoretical financialization of betting exchanges, turning the platform into an investible asset class for institutional asset managers. Using historical data from the largest betting exchange, BetFair Exchange, and sportsbooks, we can derive the theoretical risk and return profiles for this new asset class. In this new framework, traditional sportsbooks act as “highly-knowledgeable bettors” that have their own perspectives on the probability of a bet. We create a hypothetical, simple trading strategy where a highly knowledgeable bettor makes a bet when the delta between their probability and the market probability is above some epilson. Then, we utilize a Markowitz framework to evaluate this new asset class in combination with traditional asset classes, and we show that asset managers would see marginal increases in their risk- adjust returns. We also discuss the limitations to this methodology, and we note the high level of exclusivity associated with this new asset class.