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November 17, 2009

Ahead in the Count

How To Make Up a Good Trade Rumor

by Matt Swartz

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.