What does the FIFA 2022 World Cup and investment risk management have in common? What does the FIFA 2022 World Cup and investment risk management have in common? What does the FIFA 2022 World Cup and investment risk management have in common?

What does the FIFA 2022 World Cup and investment risk management have in common?

Anders Nysteen

Senior Quantitative Analyst, Saxo Bank

Summary:  Brazil and Argentina are favorites to claim the World Cup trophy in Qatar this year, but is it realistic that one of the underdogs surprises? And how does a championship for Australia relate to a loss of more than 70 % in S&P 500? - read more below.


Going into the FIFA 2022 World Cup we see numerous predictions of who will be this year’s winner – with Brazil being the current bookmaker favourite, closely followed by Argentina. But for a quantitative analyst like me, this is actually not the most interesting prediction. Why not look at the surprises we may see at the World Cup – can some of the underdogs run away with the trophy, or is it completely unlikely?

In a separate article, Saxo Strats ‘soccer experts’ present a macro-corrected prediction of who will be the winner of the World Cup.

To be able to quantify the surprising scenarios for the World Cup, we must estimate the probabilities for the different outcomes of a match, given some metrics related to each individual team. For this exercise we rank countries via their Elo rating, which is a relative way of measuring the skill level of teams/players within a certain field such as chess, baseball or soccer. The difference in the ratings has in soccer proven to be a fair predictor for the outcome of a match, with a higher probability of the high Elo rating to win. We have mixed the Elo ratings of the participating world cup teams with betting odds in order to find a mapping from the Elo ratings to the probability outcomes for each world cup match

As an example, Denmark (Elo 1971) will be facing Tunesia (Elo 1707) today. According to our model, Denmark has a 59 % of winning, 25 % of a draw and only 16 % chance of Tunisia winning.

A standard example for predictors of the World Cup winner is to assume that the team with the largest probability to will also be the winner, which in line with the bookmakers predict Brazil as winners:

Play-off rounds in the most probable scenario according to our base model.

Bootstrapping to find less-probable scenarios

Instead of going with the most probable scenario, we artificially simulate that the World Cup is played 10,000 times, using these winning probabilities to determine the outcome of every single match. The method is well-known from both science and the financial industry, and the result is 10,000 different equally-probable outcomes for the World Cup. Some of these scenarios will have some of the underdogs as winners, such as this example from the playoff rounds, where Australia turns out as winners:

Play-off round in one of the rare scenarios where Australia wins, according to our base model.

Only 2 of the 10,000 scenarios have Australia as winner, and as shown above, Australia will need events to go against the odds by beating Netherlands despite an estimated winning chance of 15%.

Combining all 10,000 scenarios, the estimated probability for each country winning the world cup is:

An overview like this reveals that the favourite scenarios with Brazil as winner is only likely in 1/4 of the cases – and that other lower-rated teams like Denmark and Uruguay have decent winning chances.

Tail scenarios in risk management

So how is this identical to investment risk management? Let say you invested in the S&P 500 index five years ago. Assuming that dividends were reinvested, the return would be 66 % on the investment which seems like a brilliant return. But one cannot mention returns without considering the associated risk of the investment. And the return is based on one realized path – but what if the macro events would have been different during the past five years? Would the investment still has been as good?

One way to quantify the risk is by applying bootstrapping to estimate all scenarios – not only the most probable one. Starting five years ago, the return of the S&P 500 index has in most of the weeks been around 0.5 %, and the return in half of the weeks has been between -1.1% and 1.7%:

Source: Saxo and Bloomberg

There are however some rarely occurring weeks with very large losses or gains, exactly like the scenarios where Australia wins the World Cup. In the worst week, the S&P 500 index lost close to 15 % of its value. Thus when doing investment considerations, these so-called tail scenarios can have quite a large impact on the performance and thus cannot be ignored, despite the small probabilities.

A standard way to quantify the impact of these low-probability events is via the bootstrapping method. We do that by simulating 5 years of performance for 10,000 different scenarios. For each scenario we create an artificial path of 5 years performance by drawing weekly return from the histogram above. Thus some of the scenarios will due to the stochasticity contain a lot of the positive weeks, some the very negative events. The latter is exactly what is of importance for investors considering their risk profile. Below we show the 10,000 simulated scenarios which could occur with equal probability, including the actual cumulative performance indicated by the black line.

10,000 simulated paths for cumulative return over the past 5 years. The black line is the path which was realized. Source: Saxo and Bloomberg

If we compare to events which (according to this basic model) have the same probability of occurring as the probability of Australia winning the world cup, i.e. 2 in 10,000, the lucky investor would have made 632 %. And the unlucky investor would have lost more than 72 % of the invested value in the worst 2 scenarios out of 10,000.

As for both the World Cup and financial investments, the least probable events are usually the most exciting ones, and bootstrapping is a simple way of quantifying these probabilities. When it comes to wealth management, tail-events can have severe impact on the performance. There are multiple ways of minimizing the impact from these tail events such as having diversified portfolios where the different assets have low correlations. Or by considering options which are far out of the money and only will be triggered in these tail events, although there is a premium associated with buying the option.

Note that the purpose of the bootstrapping exercise above is not to get the mathematical accuracies correct, but it should work as an illustration of how bootstrapping works when quantifying low-probability events. All simulated returns rely on historical data and should not be considered as indications for future returns. The used odds and Elo ratings were updated as of Nov 18, 2022.

Disclaimer

The Saxo Group entities each provide execution-only service, and access to analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Inspiration Disclaimer and (v) Notices applying to Trade Inspiration, Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular, no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/en-sg/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Markets or its affiliates.

Saxo Markets
88 Market Street
CapitaSpring #31-01
Singapore 048948

Contact Saxo

Select region

Singapore
Singapore

Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-sg/about-us/awards.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.