ANZ Finance blog |Basketball, Fund Managers, and the Hot Hand

Basketball, Fund Managers, and the Hot Hand

Published 25 March 2021

By Dr Peter J Phillips, Associate Professor (Finance & Banking) University of Southern Queensland

Basketball, Fund Managers, and the Hot Hand -- McGraw Hill ANZ Finance Blog

If you go looking in the serious economics and finance literature, you will find carefully developed scientific studies of something very interesting and seemingly completely unrelated to either finance or economics. This something is called the ‘hot hand’.

Familiar to all sports fans is the idea that a player can be on a hot streak, where everything the player does turns to gold. In basketball, when the player seems to be making every shot, the player is said to have a hot hand. The idea extends to other sports and, ultimately, to fund managers who occasionally seem to be able to go on the ‘run of their lives’.

"In basketball, when the player seems to be making every shot, the player is said to have a hot hand."

There are two important questions. The first one is, does the hot hand exist or is it a figment of the imagination? Doubt was cast on the existence of the hot hand by Gilovich, Vallone & Tversky’s (1985) paper, which concluded that the idea of the hot hand is a fallacy caused by people’s tendency to see patterns in random data that aren’t really there. After studying the shooting records of players from the Philadelphia 76ers and the Boston Celtics, the authors concluded that there was no such thing as the hot hand.

Gilovich, Vallone & Tversky’s (1985) paper set the tone for research in this field with many researchers simply accepting the conclusion that there was no such thing as the hot hand. The idea started to be called the “hot hand fallacy”. However, subsequent research has not been so unfavourable to the hot hand concept. In fact, Miller & Sanjurjo (2018) found that there is indeed a hot hand in basketball. They concluded that Gilovich, Vallone & Tversky (1985) made an error in the way they measured streaks and hot hands. Essentially, if a player makes three shots in a row, the likelihood of a fourth shot decreases and is lower than if the player had missed three shots in a row. As such, if a player shoots 50-50 after making three shots in a row, then this is evidence in favour of a hot hand, not against (which is what Gilovich, Vallone & Tversky had assumed), even though the subsequent shots include some misses.

"The more general bad news for investors from this study is that the hot hands do not last forever."

The other important question is whether fund managers can go on hot hand streaks. The evidence appears to indicate that they can. Using data from the 1975 to 1988 period and allowing for other possible explanations, Hendricks, Patel & Zeckhauser (1993) found that top performing fund managers usually do better in the next year than poor performing fund managers. Unfortunately, there is also a significant ‘icy hands’ phenomenon. Hendricks, Patel & Zeckhauser (1993) found that recent poor performers continued to generate poor outcomes for investors, and, in fact, their performance was more inferior than the hot hand fund managers’ performance was superior. The more general bad news for investors from this study is that the hot hands do not last forever.

Sports fans can feel the momentum changes in games. And the idea of the hot hand emerged from those combined millions of fan hours spent studying the games. While the research did cast doubt on this idea for a time, it appears that the fans have been vindicated. In a popular piece written for the Scientific American to accompany their more formal analysis, Millier & Sanjurjo (2018) concluded, “It’s OK to believe in the hot hand. While perhaps you shouldn’t get too carried away, you can believe in the magic and mystery of momentum in basketball and life in general, while still maintaining your intellectual respectability.” Great news for fans. And for investors.

Discussion Question

We have only mentioned a few of the many research papers that have explored this issue. See if you can find other studies for different sports and other types of activities. What are the main conclusions and how has the debate changed over time?

Further Reading

The hot hand is relevant to the discussion of share markets and investor behaviour that we present in chapters 6 and 7 of the textbook.