Updating the Scoreboard

Congratulations to the fans of the New York Knicks. Jalen Brunson, aka "Captain Clutch," and his teammates delivered the franchise's first championship since 1973, capping a memorable playoff run. The team’s 13-game playoff win streak, wild intra-game momentum swings, hot-hand shooting, and clutch play were exciting to watch.

Streaks, momentum, hot hands, and clutch performance are concepts that researchers have studied not only in basketball, but also in financial markets.

My own thinking on these ideas has evolved. Whereas the “hot hand” in basketball was seemingly debunked in the 1980s, pitting quants and casual fans in heated debates, more recent studies have partially validated the fans’ perspective. I believe that the idea of clutch performance and hot hands in sports is probably overstated due to sports reporters’ and fans’ search for patterns and stories. Nonetheless, there are moments when athletes do seem to reach a “flow state” where they are “in the zone” and perform at a higher level than competitors, or even their own base rates.

In markets, momentum has long been documented in individual stock price moves, though the effect has varied over time. For mutual funds, we can all repeat the phrase, “past performance is no guarantee of future results,” but researchers have found persistence in returns, just a much lower level than one might be inclined to expect.

In making probabilistic forecasts, Bayes' Theorem suggests that we should update our beliefs as new information arrives. The challenge is deciding how much. Overreact to the latest data point and you risk recency bias. Stick your head in the sand and ignore evidence that challenges your preconceptions and you risk sticking with outdated beliefs.

The existence of momentum does not imply that every hot streak will continue. The challenge is determining whether recent performance represents signal or noise.

Sports prediction markets appear to understand this. Despite winning the NBA championship and going 16-3 in the playoffs, the Knicks are not favorites to repeat. They are currently the market’s third choice behind OKC and the Spurs. Markets updated their beliefs, but they did not assume that one exceptional postseason meant future dominance.