British bookmaker William Hill recently got some attention when it decided to stop taking bets on whether extraterrestrial life would imminently be found. Apparently someone bet £1,000 at 1000-to-1 odds that alien life would be confirmed, putting the bookmaker on the hook for a whole lot of money. Having been stung by space-based bets in the past — they paid out big when Neil Armstrong landed on the moon — they just decided to stop taking bets on the subject.
James Surowiecki offers the following insight:
Now, on the one hand this seems perhaps overly cautious, since rather than refusing to take any more bets, the bookmakers could have simply significantly lowered the odds on aliens appearing. That would have limited their downside risk while still allowing them to profit from the more likely outcome (no aliens). But effectively, what the bookies were saying was that they didn’t know what they didn’t know, and in that situation it was smarter to limit their potential losses rather than go for more profits.
Surowiecki offers a pretty straightforward lesson to Wall Street: Sometimes it pays to throw your hands up and admit that you have no idea how something ought to be valued.
Also: In case you did’t get it from this post, or hadn’t heard it earlier, James Surowiecki (author of The Wisdom of Crowds) now has his own blog at The New Yorker. It’s called The Balance Sheet. Stick it in your RSS reader, right next to Freakonomics and Marginal Revolution.