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

Author Info

  • 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.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 4884.

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Length: 30 pages
Date of creation: Apr 2010
Date of revision:
Publication status: published in: Journal of Political Economy, 2010, 118 (4), 723-746
Handle: RePEc:iza:izadps:dp4884
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Keywords: favorite-longshot bias; pricing under risk; probability weighting; compound lotteries;

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Find related papers by 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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  12. Gabriel, Paul E & Marsden, James R, 1990. "An Examination of Market Efficiency in British Racetrack Betting," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 874-85, August.
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  16. Conlisk, John, 1993. "The Utility of Gambling," Journal of Risk and Uncertainty, Springer, vol. 6(3), pages 255-75, June.
  17. Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, vol. 66(3), pages 497-528, May.
  18. Marco Ottaviani & Peter Norman Sorensen, 2010. "Noise, Information, and the Favorite-Longshot Bias in Parimutuel Predictions," American Economic Journal: Microeconomics, American Economic Association, vol. 2(1), pages 58-85, February.
  19. Manski, Charles F., 2006. "Interpreting the predictions of prediction markets," Economics Letters, Elsevier, vol. 91(3), pages 425-429, June.
  20. Richard E. Quandt, 1986. "Betting and Equilibrium," The Quarterly Journal of Economics, Oxford University Press, vol. 101(1), pages 201-207.
  21. Joseph Golec & Maurry Tamarkin, 1998. "Bettors Love Skewness, Not Risk, at the Horse Track," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 205-225, February.
  22. Williams, Leighton Vaughan & Paton, David, 1997. "Why Is There a Favourite-Longshot Bias in British Racetrack Betting Markets?," Economic Journal, Royal Economic Society, vol. 107(440), pages 150-58, January.
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