What is Modern Portfolio Theory and how to apply it to sports

written by Mercurius

Modern Portfolio Theory is an economic theory developed by Harry Markowitz in 1952 in his paper “Portfolio Selection”, published in the Journal of Finance. In 1990 he was awarded a Nobel Prize in Economics for his work and his theory is still one of the most popular and successful investing strategies in Wall Street. Its focus is finance and investment, pioneering the idea that in order to maximize returns, investors should take a certain amount of risk, investing in different kinds of stocks. This principle is called diversification and reduces the riskiness of a portfolio.

Kinds of Risk

  • Systematic Risk: Market risks like interest rates, inflation, recession, wars etc. cannot be diversified away because they are inherent to the entire market or market segment; therefore they are unpredictable and impossible to avoid.
  • Unsystematic Risk: This kind of risks are directly linked to individual stocks and companies, and they aren’t correlated with market moves. While increasing the number of stocks in your portfolio, you can diversify this kind of risk.

How does it work?

Markowitz’s theory starts from the simple assumption that every investor wants to maximize his portfolio’s return while minimising the level of risk. Markowitz’s idea is that investors should create a portfolio of investments as diverse as possible. An investor shouldn’t only buy dozens of different stocks, he should also make sure they are as unrelated as possible, following the principle of diversification. However what’s most important is the number of assets and their right allocation. Markowitz introduced the concept of Efficient frontier, a curve that represents the highest expected return. Moreover his mathematical theory calculates the right allocation based on the risk of the asset in order to create a balanced portfolio according to the Efficient frontier theory

graph that show how risk and return on capital is related
Fig.1 - The Efficient Frontier

How to apply it to sports

Sports betting, and especially value betting, can benefit from Modern Portfolio Theory because both are predictive markets, where the biggest difference between making profits or losses is the ability to relate risks and opportunities. In this sector, the principle of diversification is very strong because sports events aren’t correlated to each other like financial assets and their results are unrelated. Still Modern Portfolio Theory can be applied to spread the risk over several events instead of betting everything on a single one. Obviously betting randomly on more than one event isn’t enough to maximize returns, investors should be also aware of the level of risk and return of single sports events like with any other financial operation.

We can apply Modern Portfolio Theory to sports betting following 3 basic stages:

  1. Calculate a bet’s level of risk, which is the true probability of a team winning or losing. We can do it using AI’s algorithms that analyze millions of data and can estimate the real attack and defence power of a team.
  2. Identify the best expected return for each operation, that is the odds that have the highest payout.
  3. Use Markowitz’s theory to create an optimal portfolio with a perfect balance between risk and return, identifying not only the matches to bet on, but when to bet according to the risk (that is allocation).

This is how a very famous financial theory can be applied to the world of sports betting. If you’re curious about it, you should try our products! We can offer you the first algorithm that creates bets strategies, based on a completely scientific method and AI.

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