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Loss aversion and mental accounting: the favorite longshot bias in parimutuel betting

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  • Jianying Qiu

    ()
    (Max Planck Institute of Economics Jena, Strategic Interaction Group)

Abstract

Parimutuel betting markets are simpliï¬ed ï¬nancial markets, and can thus provide a clearer view of pricing issues which are more complicated elsewhere. Though empirical studies generally conclude that the parimutuel betting markets are surprisingly effcient, it is also found that for horses with lowest odds (favorites), market estimates of winning probabilities are smaller than objective winning probabilities; for horses with highest odds (longshot), the opposite is observed. This phenomenon, called the favorite longshot bias, has many explanations such as risk seeking preference, transaction costs, and non-linear transformation of probabilities into decision weights, etc. This paper combines loss aversion with mental accounting, and provides a new explanation for the favorite longshot bias. We show that the bias exists in the absence of all above mentioned reasons, and the degree of the bias differs depending on the type of the mental accounting process that bettors apply.

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Bibliographic Info

Paper provided by Friedrich-Schiller-University Jena, Max-Planck-Institute of Economics in its series Jena Economic Research Papers with number 2007-017.

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Date of creation: 30 May 2007
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Handle: RePEc:jrp:jrpwrp:2007-017

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Keywords: loss aversion; mental accounting; parimutuel betting; favorite longshot bias;

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  1. Frédéric Koessler & Charles Noussair & Anthony Ziegelmeyer, 2007. "Information Aggregation and Beliefs in Experimental Parimutuel Betting Markets," Papers on Strategic Interaction 2005-12, Max Planck Institute of Economics, Strategic Interaction Group.
  2. Frédéric KOESSLER & Anthony ZIEGELMEYER & Marie-Hélène BROIHANNE, 2002. "The Favorite-Longshot Bias in Sequential parimutuel Betting with Non-Expected Utility Players," Working Papers of BETA 2002-12, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
  3. Frederic Koessler & Ch. Noussair & A. Ziegelmeyer, 2005. "Individual Behavior and Beliefs in Experimental Parimutuel Betting Markets," THEMA Working Papers 2005-08, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
  4. Marco Ottaviani & Peter Norman Sørensen, 2004. "The Timing of Bets and the Favorite-Longshot Bias," FRU Working Papers 2004/12, University of Copenhagen. Department of Economics. Finance Research Unit.
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