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

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  • Snowberg, Erik

    () (California Institute of Technology)

  • Wolfers, Justin

    () (University of Michigan)

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 favor of the view that misperceptions of probability drive the favorite-longshot bias, as suggested by Prospect Theory.

Suggested Citation

  • Snowberg, Erik & Wolfers, Justin, 2010. "Explaining the Favorite-Longshot Bias: Is it Risk-Love or Misperceptions?," IZA Discussion Papers 4884, Institute for the Study of Labor (IZA).
    • Handle: RePEc:iza:izadps:dp4884
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    More about this item

    Keywords

    favorite-longshot bias; pricing under risk; probability weighting; compound lotteries;

    JEL classification:

    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D49 - Microeconomics - - Market Structure, Pricing, and Design - - - Other
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • L83 - Industrial Organization - - Industry Studies: Services - - - Sports; Gambling; Restaurants; Recreation; Tourism

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