How do bookmakers decide on their odds?
Typically an odds line will be placed by a bookmaker after they have performed a statistical analysis, which takes all the information they have available into consideration, for instance the team’s lineup, injuries and historical performance. Once the initial odds line has been set it will be adjusted based on market movements, meaning how much money is put on the different outcomes. The efficient market hypothesis used in financial markets states that it is impossible to beat the market, because the existing asset prices always incorporate and reflect all relevant information. So if an asset is underpriced in the stock market, it will lead to investors buying the stock until it returns to its intrinsic value or in other words a fair price. The same applies to the sports market, if a bookmaker underpriced the odds of a particular outcome, let’s say a home win to Liverpool, then smart sports traders will put money on this outcome until it is priced at a fair value. So for instance if someone places a $1 million on Liverpool to win, the odds will shift. If another person believes that the odds are now mispriced and that there is value on the other side, they might place $1 million on Manchester United to win and the odds will shift again and thus eliminating the inefficiency. The more money that is put on the outcome of a game, the more likely it is that the all of the inefficiencies have been eliminated. Thus the odds at the time the match kicks off will reflect all of the information that is in the market. This odds at the kick-off time is referred to as the closing odds.
Are bookmakers able to accurately predict the outcome of a game?
Now which bookmakers are the best at accurately predicting the outcome of a game? First, let’s define the bookmakers and exchanges into two main categories: 1) soft bookmakers, who have a low payout rate (>= 90%) and low limits on how much money can be placed on games. 2) Sharp bookmakers, who have a high payout rate (<97%) and high limits on games. What typically happens at the soft bookmakers is that they limit winning players in order to protect their profit margins. The sharp bookmakers however, choose the opposite strategy, they want to have smart bettors at their site because it makes their odds more accurate. The sharp bookmakers have much higher limits on the amount of money that can be placed on a game. This basically allows them to have more information incorporated into their odds, which makes the bookmaker able to more accurately predict the real world outcome of the game.
HOW EFFICIENT IS THE SPORTS MARKET?
Through looking at the correlation between the expected probability of a game’s outcome and the actual outcome it is possible to determine how accurate a bookmakers' odds are. From a sample size of 397,935 football games offered by Pinnacle Sports, a sharp bookmaker, there existed a high correlation (r-squared = 0.997) between the closing lines and the observed probabilities. In other words, Pinnacle’s odds accurately predicted the real world outcome 99.7% of the time. Meaning that that their odds are very efficient. In their business models, bookmakers make a tradeoff between their margin and the total turnover of bets that are placed through their service. Because Pinnacle is so confident in their odds being correct it enables their business model to rely on a high volume of money being placed on their games and them to have a low margin, 2 % and a 98% payout rate to their customers.
The majority of the soft bookmakers are European, while the sharp bookmakers operate in the Asian market. Because of the higher amount of money that is placed on games in the Asian market, it has higher liquidity. This attracts professional sports traders with large bankrolls, which increases the level of competition. The consequence being an efficient market because smart sports traders exploit any inefficiencies that occur. Now it is easier to finds arbitrage opportunities in the European market, however, the limits on how much money you can place on the game effectively puts a cap on potential earnings. Because the Asian market is more efficient, the best sports traders are only able to beat the market with a couple of +EV%. They counter-balance the lower edge by placing a high volume of trades at high sums. Because the soft bookmakers limit winning players, sports traders will eventually have to move into the Asian market.