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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Find related papers by JEL classification: C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games D40 - Microeconomics - - Market Structure and Pricing - - - General D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
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