Downside Risk, Upside Uncertainty and Fantasy Draft Selection

I recently came across a master’s thesis from the Stockholm School of Economics that applies perfectly to optimizing your fantasy football draft strategy.  “Downside Risk, Upside Uncertainty and Portfolio Selection” was published by Finance Major Taras Prykhodko back in June of 2010.

In the thesis Prykhodko outlines a simple model for evaluating risky investment decisions based on upside profit, probability of upside profit, downside loss, and probability of downside loss.  Like a fantasy football draft, the optimal asset allocation depends on the investor’s preferences with regards to these four parameters.

It all starts by looking at each round of your fantasy football draft as a one period investment decision where a perspective player’s draft value is determined by their projected statistical payoff relative to their anticipated draft position.  An upside profit is realized when a player’s output exceeds that of the players drafted ahead of him in a given fantasy league.  Downside loss is just the opposite, whether it happens because of injury, suspension, or poor performance.  It usually occurs when we assume undue risk or misjudge a player’s ability as a result of our preferred parameter mix.

A player’s risk is their potential downside loss and the probability of a downside loss.  Reward is defined as an upside profit and the probability of getting an upside profit.  The goal at any given point in the draft should always be to minimize risk and maximize reward by combining different players into one optimal asset.  This Fantasy Draft Risk-Reward Model is based on one widely accepted investment principal; the investor prefers having more to less.

You may think this model functions solely on mathematics and a decision maker could use an expected value criterion as a rule of choice (higher expect value investments are simply the preferred ones), but interestingly there are three situations where the best choice is not always the one that has a higher probability of turning out right.

1. The choice with the higher probability of being right has a small chance of turning into a disaster, but the other chance doesn’t.

Some people will choose players with higher upside profit, while others will choose players with a higher probability of profit. This is called the Allais Paradox.  It occurs in our fantasy football drafts when we are presented with two or more options with nearly identical draft values.  Some people are risk averse enough to prefer a “sure thing”, even though a player has a lower expected value, while other less risk averse people would still choose the riskier, higher-mean gamble.

A perfect example of this paradox can been seen in first round of the #TwitMock Fantasy Football Mock Draft 2012 on DavidGonos.com

With the 9th pick in a 12-team standard scoring league, Bob Harris of FootballDiehards.com took DeMarco Murray RB (DAL) ahead of MJD, Marshawn Lynch, and Matt Forte.

Matt De Lima of FFToolbox.com took Jones-Drew with the next pick and Tweeted:

“Late 1st round picks are all high risk/reward. I’ll take that risk since MJD is a huge steal at 1.10 if he plays 16 games.”

We all know selecting MJD in the first round could be disastrous if the RB holds out into the regular season.  Here, Bob Harris was willing to sacrifice higher upside for a higher probability of profit. He knows he drafted a player that is projected to start the entire season and receive the bulk of his team’s goal-line carries.  Bob’s draft parameter mix led him to select DeMarco Murray over any of the other available backs because he perceives Murray to have a greater margin of safety.

“Like the stock market, fantasy football requires that we make picks with imperfect knowledge of what the future holds.  There are a number of risk factors which impact fantasy football.  You have schedule risk, age risk, usage risk, and injury risk.  Reducing the potential impact of the negative effects of risk is what the Margin of Safety is all about.” – Fantasy Douche “The Margin of Safety”

2. The choice with a lessor chance of being better has a small chance of offering giant rewards while the first choice does not.

Each and every draft selection carries an element of risk and uncertainty. Some people are willing to accept a higher downside loss and a higher probability of loss in order to have the possibility of getting infinite upside profit.

It’s like buying a $2 ticket for $320 million Power Ball drawing. I know my odds of winning are still 1:175,223,510 but the cost of the ticket relative to the payout is cheap enough for me to throw logic out the window.

This is called the St. Petersburg Paradox and it is exactly what Matthew Berry uses to describe his approach to drafting Michael Vick.

“The logic from last year remains the same, the price is just cheaper this year.  If he stays healthy, he has the ability, the weapons around him and the offensive scheme to put up the greatest fantasy season ever. Period.  Tons of upside, obvious downside, as well.” – Loves and Hates for 2012

The St. Petersbug Paradox plays out in our fantasy drafts when a risky players like Vick finally reach a value no rational owner is willing pass on.  Fantasy owners targeting Michael Vick in their drafts must have a risk tolerant parameter mix and be willing to abandon the traditional “Floor Early, Upside Late” mentality.

Chances are they’ll agree with the last example too.

3. If I pick the alternative with a greater probability of being the better one I am stuck with it, but the same is not true for the other choice.

Due to the scarcity of top-tier RB’s and last year’s QB explosion, this example is more relevant to the first round of fantasy football drafts than it has ever been. In the “Logical Decisions” chapter of Fighting Fuzzy Thinking In Poker, Gaming & Life author David Sklansky uses the analogy of painting your house to describe this concept:

“If I’m not sure whether I’d like to have my house painted white or black, trying white first is probably best.  Now, if I don’t like it, I can paint black over it, but not the other way around.”

So if fantasy players were color palettes from Sherwin-Williams, the top-tier running backs would all be the boring variations of solid white; they are the base for a robust spectrum of talent the can adapt to change throughout the season.

Frank DuPont – @FantasyDouche elaborates on initiating a robust draft strategy in “The Manitfesto: On Robustness”.

He explains that “Taking RBs and WRs early and often though is a recipe for robustness.  You’re planning for them to be busts and get hurt, and if they turn out not to be busts because you’re demanding value from each pick, then you can trade them into a QB.”

Essentially I am looking at drafting a QB in the first round the same way I would starting a project with black paint.  There are a couple of shades I really like, but I can never find a the ideal spot to apply them.

To me Chris Johnson, Matt Forte, Darren McFadden, and MJD are better options to begin with than Aaron Rodgers or Tom Brady.  Personally, I am formulating a draft strategy around owning one or two of these flex eligible options rather than starting with solid black at QB.  Essentially my game plan is based on my philosophy as an investor; in this situation I prefer a parameter mix that is guaranteed not to get a probability of profit at RB lower than a certain level.

Now, let’s test your risk tolerance.

Pretend there is a non-transparent jar that contains 30 red balls and 60 balls that are either yellow or black.  The total number of balls is always 90, but we never know how many are yellow or black.

Now I’ll offer you two choices.

Option A – You receive $100 if you draw a red ball or a yellow ball

Option B – You receive $100 if you draw a black ball or yellow ball

While you are guaranteed to win 60-out-of-90 times if you choose Option B, the alternative offers a probability of 90/90 if there are no black balls in the jar.

Which one did you choose?

I chose B.  The majority of people select Option B too despite the fact that this choice does not offer the highest possible probability for upside profit.  This observed behavior is known as the Ellsberg Paradox.

I accept that the probability of upside profit may be lower with a non-QB selection in the 1st Round, but its a move I am willing to make based on my preferred parameter mix. I see more value in securing two robust running backs ranked in the Top 15 and then adjusting to a “Value Based Drafting” Strategy the rest of the way out.

JJ Zachariason – @LateRoundQB sums it up best in the takeaway of “Risk, Reward and 2012 First-Round Running Backs”.

“At quarterback, Tom Brady and Aaron Rodgers may appear to be ‘flawless’, which they kind of are, but when you look at the competition throughout the NFL, the quarterback position is becoming much more competitive. When it comes to value based drafting, you’re still taking a risk with an early-round elite quarterback because you’re not obtaining as much value as you would at the running back position.

All in all, it’s simple: The smaller number of true, proven, top-tier running backs there are, the more valuable getting those players becomes. When there’s less of something you need, demand becomes greater.”

My Conclusion:

Any fantasy football draft strategy can be broken down into a parameter mix consisting of: upside profit, the estimated profit; probability of getting an upside profit; downside loss, the estimated loss and probability of getting a downside loss.

Understand that the best choice with the highest probability of profit can be bypassed with a robust draft strategy and detailed evaluation of your own parameter mix.  The more you understand your own risk tolerance, the better you will be at making decisions on draft day.  Remember that the ultimate goal of the Fantasy Draft Risk-Reward Model is to minimize the risk and maximize the reward of each draft selection by combining different players into one optimal asset.

You can share your draft day strategies with me on Google+ or Twitter @GoProFS24. You can also share your thoughts in the comments section below.  For more player specific draft advice checkout the iDraft War Room at PigskinBoss.com

Thanks for reading & good luck in your drafts!

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