As March drags on two important events happen: the first day of spring and the NCAA March Madness Tournament. I found a fun article in the New York Times that connects the bracket from the tournament (over 11.5 million were made) to making predictions in the financial markets. The main connection is that people are rewarded for taking against-the-grain picks that pan out. It also shows the importance of overcoming biases to make sound investing decisions.
They wanted to see how the expectations of the readers who entered bracket differed from the other types of projections of the likely tournament outcomes. Their main question was “How do our readers’ forecasts compare with purely quantitative measures of the likelihood of tournament success?” All of the sources of the tournament projects were more or less similar, especially in dealing with who had the best chance to win it all (most people say Kentucky, I say Duke) and those who have the least likely chance to win it all (the number 16 seeds). “But the divergences that do exist are a fascinating study in cognitive bias, in particular the “familiarity heuristic,” or a tendency to overweight the value of that which is familiar to us.” This is why people are more likely to stick with what they have always done rather than analyze which offers the greatest quality for the price.
The article wraps up saying why some of the readers weigh some characteristics to the team statistics. The main three measures for these readers are:
- Based in the Northeast, which has the heaviest concentration of readers (St. John’s)
- Academically elite schools (Davidson and Harvard)
- Teams that have had recent success in the NCAA tournament (Butler and Wichita State) or a long track record of excellence (powerhouses like Duke, UNC, Kentucky, Michigan State, Kansas).
and
Granted this was a fun article the New York Times posted, but is there anything we can learn from this event?
8 Comments
I think that the “familiarity heuristic” is a really interesting takeaway from this post. I know when I made my bracket I tended to pick teams who I knew had previous success in the tournament just because it felt like a safer bet. I think this could potential correlate to financial markets because people might be more likely to invest in stocks that have had recent success or are a bigger household name, although a more objective analysis might provide more accurate indicators.
I enjoyed this article and definitely agree with Andrew about the “familiarity heuristic” and how it relates to investing. I’ve done some limited investing, and the first stock I ever purchased was in Johnson and Johnson. I chose JNJ simply because I was familiar with the company and liked their products, not because of any financial metrics. I recently learned in my finance course with Professor Kester that many people view the market as unbeatable, thus it’s best to just invest in an index like the S&P 500, as opposed to paying extra for actively managed funds in the same asset class. This could be the same with March Madness — the more simplistic the approach, the better?
There are a number of interesting parallels between financial markets and the NCAA tournament. People often hedge their upset picks by picking more “powerhouse” teams, just as someone investing in stocks might balance out a riskier stock by investing in a blue chip stock. Long-term investors often look at company management to determine the strength of that company, just as we look at a head coach to determine the strength of a basketball team. Definitely a fun article!
I don’t follow basketball and therefore didn’t make a bracket. I guess this is the familiarity heuristic working in absolute terms.
I went to ESPN marketing and their job is to play off of people’s proclivities to get them to consume more sports entertainment, more generally all marketing seems to be more effective when it can be targeted.
Ironically, I’ve found that when picking a bracket, the less you know the better. Every year my brothers, dad and I do a bracket pool and every year my older brother wins. He finds a new method every year to pick the teams, because he doesn’t follow college basketball at all during the regular season. He will pick them by jersey, mascot, state, etc., and every year he always wins because he has no prior bias.
That said, I’m not sure “the less you know, the better”, works in the same manner when investing in the market. Either way, interesting article.
This is a very interesting and intuitive article. Proximity breeds familiarity, so why wouldn’t people place bets on the organizations they know best? I also agree with Andrew’s point that we typically have short-term memories and go with companies that have the most recent success.
I am very interested by the idea of the familiarity heuristic. You wonder if people who are familiar with the idea and try not to rely on what they already know become more successful. As Porter mentioned sometimes picking based on a random factor works out but it would be interesting to study those who were aware that they were picking according to what they knew and those who made a conscious decision not to do so.
So what (if anything) carries over into macroeconomics? Modern DSGE macro models assume rational expectations for aggregates — all investors, all consumers. This provides a wealth of data on micro behavior, but we should be able to formulate measures of how whether the mean performance is accurately forecast. Now sudden death playoffs make this more challenging because there’s variance in team performance, most have a record that includes a share of losses, so a stochastic model will generate upsets. Still, if expectations are misplaced even with a simple process with which large numbers of Americans are familiar, then surely we ought to be highly skeptical of any macro model that assumes a rational representative consumer optimizing successfully in the face of complex interactions between investment, incomes, monetary policy, exchange rates, asset prices and so on.
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