November 17, 2009

Ahead in the Count

How To Make Up a Good Trade Rumor

by Matt Swartz

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Big baseball fans love October; huge baseball fans love November, too. Now, I'm not talking about the occasional World Series that peeks around the corner into November, I'm talking about Hot Stove season. The Hot Stove League is a great circuit for baseball fans, because every team is currently undefeated and nobody other than the most recent draft class is untradeable. Anybody could potentially be out there on the mound pitching your team a shutout on the first Monday of April. Anybody could be hitting a grand slam for your team in the first inning.

Unfortunately, this is when we see some very ridiculous trade rumors come about and people take them seriously. Those among us who have a sense of how baseball economics works can smell these a mile away. In this article, I am going to take a look at a few huge mistakes that people make when thinking about baseball trades. This can serve one of three purposes. First, it can help you figure out whether your GM helped or hurt your team by making a trade when one does happen. Second, it can help you figure out whether a trade rumor being floated makes any sense. Third, it can help you invent a ridiculous rumor to float around on the internet that you can pretend is plausible. Sound like fun? Good. Let's get started.

1. Salary Matters. Stop simply comparing players and trying to trade players for others of a similar caliber. You need to take into account the opportunity cost of spending money on a certain player. Roy Halladay is the hot topic this winter, and one season of Roy Halladay will win you about six more games than replacing him with a cheap replacement player. However, Roy Halladay costs $15.75 million for 2010. A team that took that money and spent it on free agents would get about 3.5 wins above replacement. What that means is that Roy Halladay is worth about 2.5 wins for this season if you trade for him. So, he is worth the same as a decent but unspectacular third starter would be for free. Don't compare him to a young ace. No one will trade him for a young ace who is a sure thing.

2. Years Under Contract Matter. The most ridiculous trade rumors come when people do not consider how many years are left on a player's contract. Roy Halladay with all expenses paid is worth six wins. So are two players who are worth three wins. So is one player who is worth three wins for two years in a row. The counterargument to this is that sometimes the extra three wins gets you over the hump but the first three wins do not get you into the playoffs on their own. However, this ignores the fact that the standard deviation of a team's win total will be about six or seven wins different than their true talent level. There is too much variance to know exactly where you and your divisional rivals will finish. Therefore, the value of two years of a three-win player is very close to the value of one six-win player when we ignore everything else. Trading a young player with half a season under his belt, but who has a pretty well understood skill level is a very valuable thing-players do not reach free agency until they have six full seasons under their belt. That player is going to get the league minimum for three years and three years under salary arbitration where they will get salaries of approximately 44 percent, 61 percent, and 64 percent of their market value (according to John D. Burger and Stephen J. K. Walters of Loyola College in Maryland). Therefore, getting six years of a player only requires "paying" for 1.7 years of their actual value. So, it's like getting 4.3 years of their value for free. Thus, even a 1.5-win player with six years remaining on his contract can be worth as much as Roy Halladay.

3. Draft Pick Compensation Matters, but the Probability of Signing the Player to an Extension Does Not. The price of any free agent depends on the opportunity cost of signing them. Teams bid for free agents in an auction setting, which means that teams are going to bid players up to their true value. Of course, teams will have slightly different valuations for individual players, but teams will bid each other up to the point where they are no longer better off if the player says yes. For Type-A free agents, that is the point, where they surrender their first-round draft pick, or if they are the team whom the player played for the previous season, where they forgo the opportunity to get a draft pick from another team and a compensation pick between the first and second rounds. The value of one pick near the end of the first round is about $2.5 million, and the value of two picks is about $5.0 million. Of course, there are other little factors that affect a player's value, but chances are good that you are just not going to get a bargain when you sign your own free agent-especially if you just acquired him by trade. It's a good rule of thumb to assume that the benefit of signing a guy who is likely to get Type-A compensation is worth $5 million beyond the net value of holding his contract, or approximately 1.1 wins. If the team re-signs him, they are probably paying a price approximately equal to his value, minus the two draft picks. The general point is that whether your team can sign the player to the extension is not really all that relevant, because their alternative is going onto the free agent market and paying the fair price for talent there instead.

4. Differing Estimates of Player's Skills are Not Necessary for a Trade to Happen. This is related to J.C. Bradbury's "Hot Stove Myths" from last week, in which he explains that there does not need to be a winner and a loser in every trade. Although sometimes GMs will trade two similar players because they both feel that the other's player is better, these trades are far less common than a situation in which two teams have comparative advantages in different things and swap with the intention of helping each other out. The most common trade is a "win-now" team trading prospects to a "rebuilding" team for their current star. This is a situation where the relative marginal value of a win is higher for one team now and the other later. These are obviously common at the trade deadline when certain teams no longer have a chance of winning. Sometimes teams trade when they both have a surplus at a position that the other team has a deficiency-again this is an example of comparative advantage. The most illogical fake trade rumors are the ones in which one team is not getting any obvious value in an area where they would need it. In both of these common types of trades, the teams probably have very similar expectations with respect to the players dealt, but they do not value this production equally because of differing player alternatives available to them, or different years in which they plan to be more competitive.

5. Quantity Does Not Make Up for Lack of Quality. The most obvious fake trade rumors are the ones where one team gets one superstar player for fifty of the other team's players. There is such a thing as replacement level, and trading fifty random guys who may or may not land on a big-league bench for an ace does not give the other team any production that they could not replicate from players on the waiver wire or in the high minors of their system.

6. You Cannot Apply These Rules to Deadline Deals Without Adjustments. The methodology specified above where you consider the number of years that the players have left on their contracts, the free agents that would be available for the salary spent on those players, and the draft picks that a team would net by acquiring a player who will soon reach free agency-these are all good rules for the offseason. However, they make no sense during the regular season. The dollar value of a win is based on the probability that that win determines whether a team makes the playoffs. We have seen the graph of the marginal value of a win before, which is largest at the point where the win is likely to determine whether a team makes the playoffs. Clearly, most free agents are acquired by teams who are near that breaking point. However, with only 60 games left in a season instead of 162, the odds of one win being the determining factor can be much higher. At the beginning of the season, there is a strong possibility that a team will fall well behind the pack or get out to an insurmountable lead, but in the middle of the season a team with a slight division lead or deficit has a lot to gain by adding a star player because they know that the odds of those wins affecting whether they make the playoffs are higher. A good example of this is my article on Roy Halladay this past July.

7. The Owner's Bank Account Does Not Matter. The question of whether a team will sign a big free-agent contract or trade of an expensive player is frequently characterized as whether the owner is "willing to pay for a winner" or "can afford it." These are silly red herrings in the discussion. Although team owners probably prefer winning to losing, they spend money in accordance with whether it will add to their profit. The owners do not spend money because you are having a hard time at work or because your significant other just left you, they spend money to make more money than they spend most of the time. If they think that adding a free agent will bring fans to their games and playoff games with even more fans, they will do it. Similarly, the state of the owner's finances rarely has anything to do with baseball. The amount of money that they just made or lost in the market almost definitely has nothing to do with whether their team will spend money on a free agent that will paid out over time as the players brings money in. Again, that comes down to whether doing so is profitable. Owners are neither being cheap or nice-they do not spend money to fix your life; they spend money to get your money.

These seven rules should provide a nice framework for readers to analyze the trade market or to make up rumors of their own. The important thing to remember is that the quality of talent involved is only a small portion of the issue at hand. An excellent source on the economics of trades and free agency can be found here, and J.C. Bradbury's article cited above provides some other important myths to keep in mind when looking at the market. Remembering the way that dollars relate to wins is essential in understanding why these transactions take place, and should make the Hot Stove season all the more exciting as you plan what you think your team should do.

Matt Swartz is an author of Baseball Prospectus. 
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