Moneyball Illustrates Efficient Markets, Not Behavioral Economics

Late last year Michael Lewis, author of Moneyball, published The Undoing Project: A Friendship that Changed Our Minds, about the collaboration between Amos Tversky and Daniel Kahneman, whose work gave birth to behavioral economics. In the preface to The Undoing Project, Lewis explains how Moneyball lead to The Undoing Project:

The ways in which some baseball expert might misjudge baseball players – the ways in which any expert’s judgment might be warped by the expert’s own mind – had been described years ago by a pair of Israeli psychologists, Daniel Kahneman and Amos Tversky. My book wasn’t original. It was simply an illustration of ideas that had been floating around for decades and had yet to be fully appreciated by, among others, me.

Lewis cites Richard Thaler and Cass Sunstein’s 2003 review of Moneyball in The New Republic as what initially piqued his interest in Kahneman and Tversky’s work. Thaler, of course, won the Nobel Memorial Prize in Economics last year for his work in behavioral economics.

The thing is, though, the story that Moneyball illuminates the insights of behavioral economics regarding the persistence of systematic error and inefficiencies, doesn’t quite work. Moneyball is the story of how Billy Beane exploited systematic error and inefficiencies in the then-existing market for baseball players to turn a low-payroll baseball team into a team that competed with, and won against, teams with much heftier payrolls.

That’s not a story of systematic error; that’s a story of eliminating systematic error in a market. Billy Beane was essentially an arbitrager, taking advantage of new information to identify and exploit differentials in market evaluations of player values versus the values indicated by his.

Let me restate that: Beane wrung out systematic errors and inefficiencies in the players’ market by seeing he could exploit players undervalued by other teams. In taking advantage of what others missed, however, Beane exemplified the implications of the efficient markets hypothesis. Through his actions, he (and others) would reveal hitherto unknown information to the market, with prices subsequently adjusting to reflect the new information. This does not mean that every decision of Beane’s was correct. But his approach took advantage of information others neglected.

Neglecting useful information is behavioral economics. An entrepreneur profiting from information others ignore, is the way the market’s incentive structure is supposed to work.

Indeed, the subsequent fall of “Moneyball” as a winning strategy is consistent with a dynamic version of the efficient markets hypothesis. When one or a few individuals discover, or uncover, information relevant to a market, it can be exploited for extraordinary gains by the one or few knowledgeable individuals. As the new means of acquiring relevant information becomes dispersed in the market, or even as the information in the hands of the few becomes increasingly revealed to the market through the price mechanism, the extraordinary gains disperse as well. As with arbitragers in the financial markets, the big gains are gone, it’s merely a matter of picking up fractions of a penny here and there. This is not the failure of the efficient markets hypothesis, this is the very prediction of the efficient markets hypothesis.

The ability of the Red Sox, for example, early on to use the “Moneyball” approach successfully, then growing disenchanted with it as it ceased to generate outsized results, is simply the equilibrium outcome. When everyone has the same information, there are no inefficiencies to exploit. To be sure, variations in equilibrium outcomes still exist, but they result from true. Once the new information is built into market prices, there’s no more systematic advantage to the “Moneyball” approach. Teams once again rely on the expert, albeit idiosyncratic, judgments of trusted scouts to identify talent. (It’s not an either/or, however. It’s that one system can no longer dominate the other. So teams mix what they use.)

But why did it take so long for baseball to produce a Billy Beane? That is, a person who would exploit the systematic misperception and inefficiencies in the market for baseball players? In their review, Thaler and Sunstein argue,

Why do professional baseball executives, many of whom have spent their lives in the game, make so many colossal mistakes? They are paid well, and they are specialists. They have every incentive to evaluate talent correctly. So why do they blunder? In an intriguing passage, Lewis offers three clues. First, those who played the game seem to overgeneralize from personal experience: “People always thought their own experience was typical when it wasn’t.” Second, the professionals were unduly affected by how a player had performed most recently, even though recent performance is not always a good guide. Third, people were biased by what they saw, or thought they saw, with their own eyes. This is a real problem, because the human mind plays tricks, and because there is “a lot you couldn’t see when you watched a baseball game.”

Well, maybe. There are a couple of possibilities I’ll discuss below. First, though, it’s important to note what Thaler and Sunstein explain, and what they don’t explain. Thaler and Sunstein explain inefficiencies before Billy Beane. They do not explain the emergence of a Billy Beane, and they do not explain the effect of Billy Beane had in wringing out precisely those earlier inefficiencies they identify in the pre-Moneyball market.

While we can certainly ask why it took the baseball market so long to produce a Billy Beane. We can also turn the question back around and ask Thaler and Sunstein to explain why, in their account, would they expect a Beane ever to emerge at all?

Back to the question of the timing of the rise of Moneyball in baseball. There seem to be two factors. First, the acquisition and use of information is costly. Secondly, Moneyball arose just at the time technology made accessible the acquisition and use of hitherto inaccessible information.

First, learning, information acquisition and manipulation, and the search for information can be costly. In the case of Moneyball, it was the manipulation of information that was the pivotal issue. All the information existed in raw form. What changed, though, was the dramatic downward shift in the cost of manipulating the data that existed so that it could be used systematically. This was provided by Beane’s assistant, Paul DePosta and his computerized spreadsheet.

Beane’s entrepreneurial genius was to recognize the new possibilities, and to be the first to take advantage of those new possibilities on a systematic scale. And, to be sure, there is a part of the story that behavioral economics can continue to tell. To wit, explaining the resistance Beane received initially, and the resistance to the approach among other teams. But Billy Beane solved the problem of systematic misperception in the player’s market by seeing a use for information before others did. That’s not behavior economics, that’s the market solution to systematic misperception that entrepreneurs and markets provide.

Now, don’t get me wrong. I expect the above sounds like unalloyed cheer leading for the efficiency of markets and the rejection of behavioral economics in toto. I do neither. This story, however, the Moneyball story, illustrates what can happen when an imaginative entrepreneur sees what others do not. Beane saw the existence of systematic misperceptions in the market for baseball players, baseballs players being underpriced relative to their true potential, and exploited that misperception to the benefit, if temporarily (which also reflects the efficient work of the market), of himself, the otherwise underpriced players, and the fans of the Oakland As.

Reader Discussion

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on April 26, 2018 at 06:16:14 am

I think that Moneyball makes a basic error. (Which may not be as major as I originally thought, given that the effect has been arbitraged away.) The basic error is that of the objective function, goal of the baseball-team manager. Moneyball assumes that the goal is to maximize wins, whereas the actual goal is to maximize revenues.

The two goals conflict if the fans are coming to games to see highly-paid sluggers battling it out. The statistical prescription for winning is to fill a team with players who hit lots of singles and generate lots of walks, which might seem boring to a spectator. So, following the Moneyball strategy might actually reduce attendance and revenues.

Parenthetically, I wonder if the focus on winning with singles and walks has contributed to the issue with slow play that baseball is currently contending with.

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on April 26, 2018 at 11:39:10 am

Money ball is a crock: https://politicsandprosperity.com/2012/08/07/pseudoscience-moneyball-and-luck/

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on April 26, 2018 at 18:06:50 pm

Moneyball assumes that the goal is to maximize wins, whereas the actual goal is to maximize revenues.

I’m not a huge sports guy, but I recall fondly the ABC TV series “Coach.” Arguably the shows longest story arch involved the gradual corruption of the principled, meritocratic football coach Fox. A real man’s man, intimacy was not Fox’s thing—but as a gesture of opening up to his girlfriend, he shares with her his most prized possession: a film of his team’s best game. The girlfriend is astonished to realize that Fox’s team loses. “There’s no shame in that; the other team was better. The point was that my guys made the other team EARN their victory. They executed plays to the best of their ability. They didn’t make mistakes. And they fought to the end, even long after the outcome was clear.” This, for Fox, was the definition of virtue.

But over time, Fox is tempted by the prospect of career advancement into taking steps to promote victory even at the expense of virtue. For example, he persuades a player to make his tackles harder in order to beat up a rival team. “You just want to have fun? Well, WINNING is fun!” The player follows his direction—and paralyzes a rival player.

Fox has a strategy for getting into the NFL, but he fails to implement it, and thus is resigned to his career plateauing—until he is offered a job as an NFL coach based on nothing more than his personal relationship with a rich widow who knows nothing about football. This is another blow to his concept of meritocracy: chance and personal connections, not strategy, are the source of his success.

And once installed in his new post, his must endure the owner’s whims. She trades away the team’s first round draft pick in exchange for a pair of cruise tickets. And she forces the team to pick a player for no other reason than that he’s good-looking, and she hopes to boost viewership among women. Coach reluctantly extends the job offer, but informs Prince Charming that the job is being offered merely because of the player’s looks, not his playing ability. And it yet another blow to Coach’s masculine, meritocratic principles, the player is perfectly willing to accept employment under those terms.

While each affront to Coach's values is played for laughs, the cumulative effect is to illustrate how much the real world of sports deviates from the idealized one.

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on April 28, 2018 at 08:27:58 am

Another example of an efficient market in sports was given in "Soccernomics", by Simon Kuper and Stefan Szymanski.

The question arose as to whether there was racism in English soccer teams, and whether they discriminated against black players. Surprisingly, that can be measured statistically with reasonable certainty. The authors discovered that there was a 92% correlation between teams standings and salaries paid, i.e. teams with better players earned more money and finished higher in the standings. If there WAS discrimination, than a soccer team would hire a white player in preference to an equally talented black player. As a result, black players would be forced to accept lower salaries to get a job- an inefficiency in the soccer market. Take a multiple regression on black players, team performance, and team salary. Given two teams with the same salary, if the team with more black players performed better, and the differences were statistically significant, THAT would be a sign of discrimination. It turns out there WAS discrimination against blacks in the 1980s, but some teams picked UP on that, just like the "Billyball" baseball teams, and got winning teams more cheaply. Other teams notice the inefficiency, and by the 1990s the salary discrepancy had disappeared.

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Alan D McIntire

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