The NY Times reported today that the St. Louis Cardinals hacked the Houston Astros’ internal files, including information on the trade market. I suspect that everyone has a basic understanding why the Cardinals would find this information useful. “Knowledge is power,” as they say. Heck, the United States spends $52.6 billion each year on spying. But game theorists have figured out how to quantify this intuition is both interesting and under-appreciated. That is the topic of this post.
Trades are very popular in baseball, and the market will essentially take over sports headlines as we approach the July 31 trading deadline. Teams like to trade for the same reason countries like to trade with each other. Entity A has a lot of object X but lacks Y, while Entity B has a lot of object Y but lacks X. So teams swap a shortstop for an outfielder, and bad teams exchange their best players for good teams’ prospects. Everyone wins.
However, the extent to which one side wins also matters. If the Angels trade a second baseman to the Dodgers for a pitcher, they are happier than if they have to trade that same second baseman for that same pitcher and pay an additional $1 million to the Dodgers. Figuring out exactly what to offer is straightforward when each side is aware of exactly how much the other values all the components. In fact, bargaining theory indicates that teams should reach such deals rapidly. Unfortunately, life is not so simple.
The Risk-Return Tradeoff
What does a team do when it isn’t sure of the other side’s bottom line? They face what game theorists call a risk-return tradeoff. Suppose that the Angels know that the Dodgers are not willing to trade the second baseman for the pitcher straight up. Instead, the Angels know that the Dodgers either need $1 million or $5 million to sweeten the deal. While the Angels would be willing to make the trade at either price, they are not sure exactly what the Dodgers require.
For simplicity, suppose the Angels can only make a single take-it-or-leave-it offer. They have two choices. First, they can offer the additional $5 million. This is safe and guarantees the trade. However, if the Dodgers were actually willing to accept only $1 million, the Angels unnecessarily waste $4 million.
Alternatively, the Angels could gamble that the Dodgers will take the smaller $1 million amount. If this works, the Angels receive a steal of a deal. If the Dodgers actually needed $5 million, however, the Angels burned an opportunity to complete a profitable trade.
To generalize, the risk-return tradeoff says the following: the more one offers, the more likely the other side is to accept the deal. Yet, simultaneously, the more one offers, the worse that deal becomes for a proposer. Thus, the more you risk, the greater return you receive when the gamble works, but the gamble also fails more often.
Knowledge Is Power
The risk-return tradeoff allows us to precisely quantify the cost of uncertainty. In the above example, offering the safe amount wastes $4 million times the probability that the Dodgers were only willing to accept $1 million. Meanwhile, making an aggressive offer wastes the amount that the Angels would value the trade times the probability the Dodgers needed $5 million to accept the deal; this is because the trade fails to occur under these circumstances. Consequently, the Angels are damned-if-they-do, and damned-if-they-don’t. The risk-return tradeoff forces them to figure out how to minimize their losses.
At this point, it should be clear why the Cardinals would value the Astros’ secret information. The more information the Cardinals have about other teams’ minimal demands, the better they will fare in trade negotiations. The Astros’ database provided such information. Some of it was about what the Astros were looking for. Some of it was about what the Astros thought others were looking for. Either way, extra information for the Cardinals organization would decrease the likelihood of miscalculating in trade negotiations. And apparently such knowledge is so valuable that it was worth the risk of getting caught.