Testing Rationality in the Point Spread Betting Market

This paper presents empirical tests of market rationality using data from the point spread betting market on National Football League games. Data from this market avoid many common pitfalls of tests of rationality in conventional financial markets. The authors test for rationality with two types of tests, statistical and economic. Results of the tests reveal that the statistical tests cannot reject market rationality while the economic tests do reject market rationality. MARKET RATIONALITY CAN BE empirically examined with either pure statistical tests or direct economic tests. Statistical tests look at statistical properties of markets, such as price correlations. Economic tests attempt to detect unexploited profit opportunities. This paper compares the results of these two types of rationality tests with data from the point spread betting market on National Football League (NFL) games. We conclude that the statistical tests are too weak to reject rationality in a market where irrationality appears to exist. Our results are strikingly consistent with those of Summers [26], who simulated a model of stock prices incorporating nonrational expectations and then showed that standard statistical tests are too weak to detect the absence of rationally formed expectations. Summers employed simulation because market rationality is difficult to test directly in conventional financial markets: the ongoing nature of securities markets means that there exists no point at which an objective fundamental value can be observed and compared with actual prices.' In contrast, the point spread market offers an objective, though uncertain, game outcome to decide the end-of-horizon payoff. Moreover, once a bet is placed in these markets, the impact of subsequent betting does not affect the odds on the placed bet (unlike pari-mutuel betting). Because of this elementary market

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