GOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOAL!!!!!!!!!!!!!!!!!!!!

(The World Cup and Equity Markets)

No-one now really believes humans are rational, either individually or in aggregate. And the entire field of behavioral finance is predicated on this fact.

The effects that relate to the market have often been strange. Researchers have linked stock returns to holidays, Netflix, the doomsday clock, cloud cover, seasonal affective disorder, and lunar cycles. Much of this literature is entertaining but not especially convincing. Many of the effects are small, difficult to replicate, or vulnerable to accusations of data mining.

Then there is football (“soccer” if you insist on being wrong).

In 2007, Alex Edmans, Diego Garcia, and Øyvind Norli published one of the most famous papers in behavioral finance: Sports Sentiment and Stock Returns. Their findings were simple, surprising, and difficult to explain away. When a national soccer team loses an important match, the country’s stock market tends to fall the next trading day.

This only sounds ridiculous to those who don’t know how emotionally invested fans get. And emotion is heightened at World Cups where you need to wait four more years for a chance of redemption.

So, the authors were not really studying soccer. They were studying mood.

Financial theory traditionally assumes that investors evaluate risk and return objectively. Behavioral finance argues that emotions can affect decision making. A challenge is finding situations where emotion changes, but fundamentals do not. Major sporting events provide exactly this opportunity.

When England is (inevitably) eliminated from the World Cup, nothing meaningful happens to the cash flows of British companies. The same is true when Brazil loses, Germany loses, or Argentina loses. Yet millions of investors suddenly experience disappointment, frustration, and pessimism.

If mood influences risk taking, we should observe it in asset prices.

That is exactly what the authors found.

Using data from dozens of countries and many years of international soccer competitions, they documented significant negative stock returns following losses by national teams. The effect was strongest for soccer and particularly strong for World Cup elimination matches.

And another interesting finding is that losses matter much more than victories.

You might expect symmetry. If losing makes investors unhappy, winning should make them happy. A loss should produce a negative return, and a victory should produce a positive return. That is not what happens. The negative effect after losses is substantial. The positive effect after winning is much weaker and often statistically insignificant.

But this should sound familiar to anyone who studies behavioral finance. Humans react more strongly to losses than gains. Psychologists call this loss aversion (traders call it “obvious” and “something you won’t find in a book”). The pain of losing is generally larger than the pleasure of winning. The stock market appears to reflect the same asymmetry. An unexpected defeat can ruin an investor’s day. A victory produces satisfaction, but not to the same degree.

This is one of the reasons the result feels psychologically plausible. The market response mirrors a well-known feature of human behavior.

For World Cup elimination losses, the authors estimate an abnormal daily return of roughly 0.5%. A half percent move in a broad equity market is not trivial. More importantly, the effect appears in situations where there is no obvious information about corporate fundamentals.

Most anomalies in finance can be attacked from multiple directions. Perhaps they are compensation for risk. Perhaps there is a hidden economic factor. Perhaps investors possess information that researchers cannot observe. Those explanations are much harder to apply here. A soccer team losing a knockout match simply does not provide meaningful information about future corporate earnings. That is why the paper became a classic.

But obviously, not everyone agrees that mood is the entire story. A related strand of research focuses on attention rather than emotion.

Researchers have documented lower trading activity during major World Cup matches. This is not surprising. Traders, portfolio managers, and retail investors are all watching the game instead of watching markets. In some studies, national stock markets appear to become less connected to global market movements while important matches are taking place. Investors are distracted.

This alternative explanation is not necessarily inconsistent with the mood hypothesis. Both mechanisms may be operating simultaneously. During the match, investors are paying less attention to financial markets. After a painful loss, they may become more pessimistic.

Another reason the paper attracted so much attention is that football provides a uniquely powerful emotional shock. Football is a very big deal. FIFA has more members than the United Nations. 1.5 billion people watch the World Cup final and only 120 million watch the Super Bowl. A local baseball team losing a regular-season game rarely changes national mood. Even a championship loss will affect only a subset of the population.

The World Cup is different.

In many countries it is a national event. Millions of people watch. Newspapers cover every detail. Politicians comment. Entire cities seem to stop functioning during important matches. The emotional impact is widespread and synchronized. From a research perspective, that is ideal. If you want to test whether mood affects markets, you need an event that changes the emotions of a large fraction of investors at the same time. The World Cup provides exactly that.

It isn’t clear the effect is still there. The original paper examines broad statistical tendencies across many countries and decades. Once an anomaly becomes widely known, implementation becomes more difficult. Transaction costs, timing issues, and changing market structure all matter. There is also the problem that markets evolve.

The original sample was largely drawn from a period when domestic investors played a larger role in national stock markets. Today ownership is more global. Index funds dominate flows. International capital moves rapidly across borders. If Brazilian investors become depressed after a World Cup loss, does that matter as much when a large fraction of Brazilian equities are owned by institutions in New York, London, and Singapore?

Traditional finance models often assume that market participants process information rationally and unemotionally. Real markets are populated by people who become excited, frightened, distracted, overconfident, and disappointed.

Most of the time these effects are small and difficult to measure. But occasionally the world provides a clean experiment. A nation watches its team get knocked out of the World Cup. Nothing changes about corporate cash flows. Nothing changes about interest rates. Nothing changes about economic growth, yet stock prices fall.

The legendary manager Brian Clough said, “The trouble with football is that it is all about human beings.” He could have said the same thing about the stock market.

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