Hedging sports risk.
Perhaps now that the idea has - albeit obliquely - appeared in the Economist, the legitimacy of hedging economic outcomes linked to sporting events will start, ever so slowly, to be accepted. The article talks about how the number of viewers - and thus the value to advertisers - evolves during an event as a function of ‘time until end’ and ‘uncertainty of outcome’, and then goes on to quote a researcher from London’s Tanaka Business school thinking aloud about ‘contingent’ pricing:
Broadcasters can capture some of this variation by charging advertisers on the basis of viewing figures. But ratings-based fees are retrospective and advertisers have to decide where to spend money ahead of time. Tanaka’s Stefan Szymanski thinks there is an argument for “contingent” pricing, whereby advertising slots for sporting events would be pre-auctioned, with bids depending on the score at each point in the game.
This is very much (part of) the point I was trying to make with the Google/World Cup/Sports Hedge vignette in the AmazonBay/Through the Looking Glass scenario I wrote two years ago, here is the relevant excerpt:
2014 (August) - Advertising rates for the World Cup final plummet as longshots Denmark and Iraq make it through to finals knocking out favorites Brazil and China. GoogleCorp’s stock sells off sharply until CEO Lachlan Murdoch reveals that they have hedged their exposure with €3.4 billion of payer positions on a basket of favorites in what is described as the largest ever single sports trade disclosed to date. The complex hedging strategy was designed by Allianz Sport Risk Solutions group and entirely executed using a proprietary algorithm on AmazonBay’s sports trading exchange.
The premise was that the ‘advertising infrastructure’ would be operating as a real-time dynamic market with GoogleCorp as the primary intermediary: buying and selling slots, balancing supply and demand in real-time, essentially performing a ‘market-making’ role for advertising assets. (As an aside, in this kind of world the pricing dynamics for advertising slots would be fascinating and resemble option pricing with similar issues especially wrt pricing close to expiry.) For the purposes of this example, I foresaw GoogleCorp having principle risk as well, more for the sake of simplicity (rather than adding another player to the scenario, say a hedge fund specialized in trading advertising slots…) So when both heavy favorites - each having vast and valuable home markets on their own, plus broad global followings - lose, say a 100-1 type outcome before the semis, the value of advertising slots for the final - now between two ‘minnows’ - plummets as both end users and speculators look to offload their positions. In the above scenario, GoogleCorp’s stock also sell off as the market believes it to be very long finals advertising slots and so exposed to the carnage in that market. However when the market finds out that this exposure had been hedged, the stock rebounds. The hedge in this case is decribed as a ‘payer’ on a basket of favorites; of course this is just swap market terminology for what would be called laying in the betting markets - essentially they have laid (or ‘bet against’ or ‘insured against loss’) a basket of favorites. As a simplified illustration, assume the hedge was just a simple bet that both China and Brazil would lose in the semi-finals and that the odds of this (as priced by the market) were 100-1. So for €3.4 billion of protection, GoogleCorp would need to pay €34mn of premium (their stake.)
So coming back to the idea of contingent pricing raised in the article, not only does this make sense (for both broadcasters and advertisers) but it can be enhanced considerably by bringing to bear the panoply of risk management techniques by using the liquidity and correlation provided by the underlying sporting market to create hedging instruments and incremental liquidity in the market for advertising itself (by facilitating arbitrage and speculation which should encourage additional ‘financial’ participants into the market.)
