Punters’ instinct?

If you really want to know what’s going to happen with Brexit, it might be best to ask someone down the pub.

Research shows that on the now infamous night back in 2016 when Britain voted to leave the EU, ordinary punters out to cash in on the result predicted what it would be well before the international finance markets did.

According to economists Tom Auld and Oliver Linton from the University of Cambridge, gamblers sensed the “leave” decision coming an hour before the currency experts, creating a window of “arbitrage” during which the price difference between betting and FX markets yielded up to a 7% return on the British pound (GBP).

Unless you are a particularly harsh critic of said currency experts, this may seem a little surprising. However, it does sit well with the theory of the “wisdom of the crowds”. Discovered by Charles Darwin’s cousin, Francis Galton, this theory essentially argues that a group working together will always get closer to the right answer than any individual. Of course, it’s not quite that clear cut, as Cosmos reported last year.

In the case of Brexit, the wisdom of the crowds proved a nice little earner for some, with more than 182,000 individual bets placed with one agency alone – a record for a political event on Betfair – and over 88,000 trades made in the GBP futures market in a seven-hour window.

“Clearly, punters trading on Betfair are a different group of people to those dealing in FX for international finance,” says Auld. “It looks like the gamblers had a better sense that leave could win, or that it could at least go either way.

“Our findings suggest that participants across both markets suffered a behavioural bias as the results unfolded. Initially, both traders and gamblers could not believe the UK was voting to leave the EU, but this disbelief lingered far longer in the city.”

Auld and Linton say their findings, published in the International Journal of Forecasting, support the idea that gambling, or so-called “prediction markets”, might provide better forecasts of election outcomes than either experts or polls.

Betting exchanges are an “incentive compatible” way to elicit the private opinions of participants, as people are putting their money where their mouth is, whereas they have no investment in what they tell pollsters.

For their study, the pair compared the behaviours of the Betfair betting market and the GBP-to-US-dollar exchange rate from closure of the polls at 10pm, when odds of 10-to-1 were being offered on Brexit.

Both markets were very slow to react despite the data already available and the votes flooding in from across the country. This meant there was money to be made by trading early on either market.

The betting market moved to a “leave” result around 3am, by which time Brexit odds had reversed (1-to-10). However, the foreign exchange market didn’t fully adjust to the reality of Brexit until around 4am. At 4:40am the BBC predicted a “leave” victory.

Auld and Linton used the expected outcomes for each voting area – data that was publicly available prior to the referendum – to create a “forecasting model”. By adjusting it with each actual result in turn, they say, it would have predicted the final result from around 1:30am had it been deployed on the night.

“According to theories such as the ‘efficient market hypothesis’, the markets discount all publicly available information, so you cannot get an edge on the market with data already out there,” says Auld.

“However, using data publicly available at the time we show that the financial markets were very inefficient, and should have predicted Brexit possibly over two hours before they actually did.”