Top Of The First
It’s Math Geek Monday and I apologize in advance if I haven’t simplified today’s Rundown enough. What I am hoping to accomplish is a comparison of major league roster management and financial industry portfolio management in layman’s terms. The key term in today’s exercise is “intrinsic value,” which, simply put, is the valuation of an asset (a player in this case) independent of that asset’s market price (that player’s contract).
The 40-Man Roster As A Derivatives Portfolio
I come from a background in derivatives trading and risk management and, like everybody else, I am amazed at the escalation of baseball salaries. How do we determine what a player is actually worth? Why is Jason Heyward worth $184 million dollars to the Chicago Cubs and why is David Price worth $217 million dollars to the Boston Red Sox?
Many major league franchises are building financial risk-management models to help make better financial decisions and to protect their assets — essentially their players. Managing a major league baseball roster is no different than managing a portfolio of securities. There are so many quantifiable statistics in baseball now that you can actually create an enterprise model capable of evaluating actual vs. predicted price (projected worth) that can best predict profit (or loss) in the marketplace. In doing so, front offices can better mitigate the risk of their specific portfolios.
Analytics, big data, sabermetrics. Call it what you will, but the rise in popularity of using data in more sophisticated ways in the world of baseball has brought about a fundamental shift in how on-field success is managed. Think of it as Moneyball Plus. While putting a financial value on a single win above replacement serves as a rudimentary valuation formula, it does not account for the inherent risk in the market place. That’s why the team that “buys” or “accumulates” the most wins doesn’t always finish with the most wins. The 2015 San Diego Padres and Chicago White Sox are great examples of the failure of the strategy relating to projecting future results against past performance only.
It is also important for major league risk-management professionals to compile and extract hidden value and information from the vast amounts of data already available in their own data hubs. Two industries — finance and baseball — have tremendous parallels in the way in which they use data analytics, as both rely on data to make better decisions about their business.
In its simplest form, portfolio risk-management analytics is a set of statistical techniques that are used to examine the performance of risk-driven portfolios under different circumstances. While accumulating wins is very necessary in building an edge into to your roster, making sound decisions that best hedge that financial risk is certainly just as important. Pitchers break down. Hitters have slumps. Injuries occur.
I Know, You Were Told There Would Be No Math
So how is Jason Heyward worth $23 million dollars per year? How is Davis Price worth $30 million dollars per year?
The short answer is they are not.
A slightly more analytical method to make a valid determination is to equate the dollar value in anticipated WAR of those players vs. the actual cost to carry those contracts.
- Heyward’s projected 2016 WAR is 5.6 and at $8.4M per each win above replacement he is worth $47.04M in projected value. At a salary of $23M he carries a fundamental value of +24.04 million dollars.
- Price’s projected 2016 WAR is 5.8 and at $8.4M per each win above replacement he is worth $48.72M in projected value. At a salary of $30M he carries a fundamental value of +18.72 million dollars.
But that doesn’t paint the entire picture.
As Theo Epstein stated when he took over as President of Baseball Operations for the Chicago Cubs, you are always paying for past performance in free agency. That is certainly the case with Price. But is it also the case with Heyward?
Not necessarily. Heyward is four years younger than Price and is just hitting his peak production years. In assessing that risk, the Cubs are hedging youth against analytics vs. their cash outlay. With Price (and pitching in general, for that matter) there is greater risk. The Red Sox are hedging their investment with analytics against past performance.
In building a strong portfolio, the smart play is to put your money in an asset that can still appreciate in value rather than one that is more likely to decline. And in the case of the Cubs deal with Heyward, the opt-out gives them a second chance to reevaluate the investment in their asset before it reaches a point of age-related diminishing returns, provided Heyward meets expected projections and then exercises his opt-out. It is very similar to the financial hedge of covering a call option.
Doug Hanchett’s Playing Hardball with Big Data (pdf link) provides great detail into the use of information that is collected to calculate player values. The parallels of roster management and investment analytics into risk potential and projected future performance are endless.
Fact, Fiction, Truth, Or Rumor
Baseball front offices are split on the issue of opt-out clauses and in fact the Orioles say they won’t work in their financial structure.
Theo Epstein’s Christmas gift to Cubs fans via Peter Gammons.
The Atlanta Braves had Dansby Swanson in their sight lines even before they moved Andrelton Simmons. Atlanta GM John Coppolella has certainly owned Arizona’s GM Dave Stewart since July.
I’ve commented this on other Cubs Insider posts and Mike Petriello of MLB.com feels the same way — Wei-Yin Chen has the most remaining value of any remaining free agent pitcher. Chen compares favorably to Jordan Zimmermann.
Wow — Bryce Harper led the majors hitting .451 last season the third time he faced a starter in a game; Dustin Pedroia led the AL hitting .415.
Bottom Of The Ninth
Tomorrow I will get back to analyzing minor league depth. I know a lot of people are extremely busy this time of year, so I want to express my sincere thanks to those of you who take the time to read and comment this column each day. In the spirit of the week, I would like to wish each of you health and safe travels as you spend time with friends and family. The best gift you can give any of us is your continued presence in our lives.