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Explaining the Favorite-Longshot Bias: Is it Risk-Love or Misperceptions?

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  • Erik Snowberg
  • Justin Wolfers

Abstract

The favorite-longshot bias describes the longstanding empirical regularity that betting odds provide biased estimates of the probability of a horse winning—longshots are overbet, while favorites are underbet. Neoclassical explanations of this phenomenon focus on rational gamblers who overbet longshots due to risk-love. The competing behavioral explanations emphasize the role of misperceptions of probabilities. We provide novel empirical tests that can discriminate between these competing theories by assessing whether the models that explain gamblers’ choices in one part of their choice set (betting to win) can also rationalize decisions over a wider choice set, including compound bets in the exacta, quinella or trifecta pools. Using a new, large-scale dataset ideally suited to implement these tests we find evidence in favour of the view that misperceptions of probability drive the favorite-longshot bias, as suggested by Prospect Theory.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3029.

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Date of creation: 2010
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Handle: RePEc:ces:ceswps:_3029

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Keywords: pricing under risk; probability; weighting; compound lotteries; favourite-longshot bias;

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  20. Marco Ottaviani & Peter Norman Sorensen, 2010. "Noise, Information, and the Favorite-Longshot Bias in Parimutuel Predictions," American Economic Journal: Microeconomics, American Economic Association, American Economic Association, vol. 2(1), pages 58-85, February.
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