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

Author Info

Listed author(s):
  • 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
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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  8. Martin Weitzman, 2008. "Utility Analysis And Group Behavior An Empirical Study," World Scientific Book Chapters,in: Efficiency Of Racetrack Betting Markets, chapter 9, pages 47-55 World Scientific Publishing Co. Pte. Ltd..
  9. 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 150-158, January.
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  12. Camerer, Colin F & Ho, Teck-Hua, 1994. "Violations of the Betweenness Axiom and Nonlinearity in Probability," Journal of Risk and Uncertainty, Springer, vol. 8(2), pages 167-196, March.
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  14. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-291, March.
  15. Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, vol. 66(3), pages 497-528, May.
  16. 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.
  17. Richard N. Rosett, 1965. "Gambling and Rationality," Journal of Political Economy, University of Chicago Press, vol. 73, pages 595-595.
  18. Asch, Peter & Quandt, Richard E, 1987. "Efficiency and Profitability in Exotic Bets," Economica, London School of Economics and Political Science, vol. 54(215), pages 289-298, August.
  19. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56, pages 279-279.
  20. 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.
  21. Steven D. Levitt, 2004. "Why are gambling markets organised so differently from financial markets?," Economic Journal, Royal Economic Society, vol. 114(495), pages 223-246, 04.
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