Warren Buffett Makes Big NCAA Bet: An Actuarial Look At Odds

Warren Buffett And His NCAA Bet by David Merkel, CFA of Aleph Blog

I have no idea what premium Warren Buffett is receiving for insuring against one or more people having a perfect NCAA Tournament bracket, but it is unlikely that he will lose on this underwriting bet.  Those seeking insurance on unlikely events think the events are more likely than they actually are.  That said, for Quicken Loans, they don’t want to bet the company, and they do want publicity, so contracting with Warren Buffett is worth their while.

Imagine for a moment that the average person submitting a bracket had a 78.6% chance of getting each game right, and the maximum 10 million people sent in their brackets.  What is the likely number of correct brackets?  One.

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But does the average person get more than three out of four games right?  I don’t think so.  Are there some people that are better than others so that they get games right 90% of the time?  Well, if they are 1,163 out of the ten million, on average, one of them will have a perfect bracket.

Here’s a further problem.  Every tournament has significant upsets.  Someone who has a good understanding of how good the teams are will know how to pick the most likely team to win.  It is tough to pick the upsets, and tougher to pick all of the upsets.  There is no good model for upsets, or they wouldn’t be upsets.

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As an aside, the prize is $500 million as a lump or $25 million for 40 years.  The breakeven yield rate on that is 4.21%.  Warren Buffett knows he can beat 4.21%.

This contest is like the lottery.  If I had one piece of advice for lottery winners it would be to take the payments over time.  The discount rates on most lotteries are far higher than 4.21%, and really, taking them over time gives you a chance to learn how to manage more money then you know what to do with.  Taking the payments over time gives you the freedom to learn from mistakes.  We all make mistakes, but when we get all the money at once, we make more.

 

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.