Nova workboard

a blog from young economists at Nova SBE

The problem is not in the eyes of the beholder, it is rather in the Behavior of the agent.

In line with the Professor’s question “What is the difference between a Gamble and a Financial Asset?”, the present post will try to show my perspective on these concepts and the normal misconceptions derived from them.

Information:

A Gamble has no connection to something tangible, whereas a Financial Asset is based on something you can (in principle, partially) own. Before rolling the dices there is no information you can search for, nor reasoning you can make to justify your choice – you just go with your gut.

On the contrary, before purchasing a Financial Asset, you have the possibility to (and you should!) do helpful research – regarding a sovereign bond you may think about the country’s growth perspective and analyze current fiscal health, for instance. Still, remember this type of information will always be asymmetric and comes at a cost.

Time-span:

Taking a gamble is like throwing yourself off a cliff – wait, it is not as bad, there is a safe end-zone – hoping such fall ends nicely. After the jump, there is nothing you can do and gravity (i.e, chance) will determine the outcome. Thus, if you fail to predict the outcome you lose all the money.

This is not likely to happen with a Financial Asset because when you buy one, you are able to “stay in the game” – you can monitor your position as time goes by.

Outcome:

In a gamble, the outcome must be purely random – in fact, whether you pick number 3, 15 or 23 in the Russian roulette or choose Head or Tails in a coin flip the odds are the same.

Inversely, we must not take something as a Financial Asset unless its outcome is non-random. When buying a stock, you have multiple distinctive companies working in different industries and, hence, each company has its own odd of being a good one.

Return:

If there is no information you can base your decision on, if you are not able to “stay in the game” and if the outcome is random, obviously a Gamble must be way more risky than a Financial Asset. So, being more risky, pays higher returns – and that is what makes people play.


“Stock Market is a Casino”* ?

From the previous concepts, we will now derive the definition of ‘gambling’ as a type of behavior with characteristics related to a Gamble, and ‘investing’ to be the same for Financial Assets. Since it is a type of behavior, it depends only on the player and not on the product in question – simply, even though there is information about companies, if you do not look for it before buying a stock, you are gambling. The possibility of gambling with Financial Assets is where the danger lies and the reason why some people perceive the Stock Market as a Casino. Thinking in the opposite direction, one can consider there may be room for investing in (what it is usual to be thought as) Gambles.

Let’s consider these 2 questions:

1) “Should buying and selling stocks every day be called investing?”

Since we are talking about stocks, this would generally be considered to be investing instead of gambling. But maybe we are wrong. In fact, day-to-day trading has more similarities with gambling than with investing – you decrease the importance of information, you lose the time-span and thus, you increase the likelihood of the outcome being random.

2) “Should betting on Chelsea to win the Premier League be called gambling?”

Now, it is clear you have information (players, coach, past performances, for example), you have a large time-span (if the team starts the season playing different from what you expected you could close your position) and thus, I would say it can be considered as investing.

However, I would like to make a point about what should be our main concern: economic benefits. To Economists, the definition of investment should always and somehow entail an economic benefit for society. When you buy a stock you are putting your money at the disposable of a company, which can use it to hire workers, increase productivity or product quality. When you bet on sports, at best you will only make a benefit for yourself. Still, when investment banks profit from trading different types of securities, they are in no different position than you.

In the end, I guess it is important to think about how much capital should be allocated to “gambling” at the expense of that which could be used for real Investment.


(Not that) fun fact:

* – Inside a Casino, all games have non-positive expected return for the player. Since 1926, S&P500 has, approximately, increased its value 73% of the time.

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Author: studentnovasbe

Master student in Nova Sbe

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