Open Access Open Access  Restricted Access Subscription or Fee Access

AN ALTERNATIVE EXPLANATION OF THE FAVORITE-LONGSHOT BIAS

Martin Kukuk, Stefan Winter

Abstract


Empirical studies of horse race betting in the US, the UK, Australia, and Germany have empirically established the so called favorite-longshot bias. It was found that bets on longshots on average lose much more than bets on favorites. The theoretical literature on wagering markets has offered a variety of explanations for that bias. One of the most prominent is the assumption of a homogeneous bettor population with a preference for risk. However, the risk-love explanation has also been severely challenged. We add to this challenge by proposing a different explanation of the favorite-longshot bias. We show that if populations of bettors have only noisy estimates of horses’ true winning probabilities, a favorite-longshot bias will be the market equilibrium outcome even with risk neutral bettors and even if the median estimate is correct. We provide evidence on four different types of bets broadly consistent with the noisy estimates assumption but not with the risk-love explanation.


Keywords


Horse Race, Betting, Risk, Market Equilibrium, Favorite-Longshot-Bias, Noisy Probability Estimates

Full Text:

PDF

References


Ali, Mukhtar M. (1977): Probability and utility estimates for racetrack bettors, in: Journal of Political Economy, Vol. 85, pp. 803-815.

Asch, Peter/Malkiel, Burton G./Quandt, Richard E. (1982): Racetrack Betting and Informed Behaviour, in: Journal of Financial Economics, Vol. 10, pp. 187-194.

Bird, Ron, McCrae, Michael, Beggs, John (1987): Are Gamblers Really Risk Takers? Australian Economic Papers, Vol. 49, pp. 237-253.

Bruce, Alistair C./Johnson, Johnnie E.V. (2000): Investigating the Roots of the Favorite-Longshot Bias: An analysis of decision-making by supply- and demand-side agents in parallel betting markets, in: Journal of Behavioral Decision Making, Vol. 13, pp. 413-430.

Busche, Kelly (1994): Efficient Market Results in an Asian Setting, in: Hausch, Donald B./Lo, Victor S.Y./Ziemba, William T. (eds.): Racetrack Betting Markets, Academic Press 1994, pp. 615-616.

Busche, Kelly/Hall, Cristopher D. (1988): An exception to the risk preference anomaly, in: Journal of Business, Vol. 61, pp. 337-346.

Cain, Michael/Peel, David/Law, David (2002): Skewness as an explanation of gambling by locally risk averse agents, in: Applied Economics Letters, Vol. 9, pp. 1025-1028.

Coleman, Les (2004): New light on the longshot bias, in: Applied Economics, Vol. 36, pp. 315-326.

Dowie, Jack A. (1976): On the Efficiency and Equity of Betting Markets, in: Economica, Vol. 43, pp. 139-150.

Friedman, Milton/Savage, Leonhard (1948): The Utility Analysis of Choices Involving Risk, in: Journal of Political Economy, Vol. 56, pp. 279-304.

Gandar, John M./Zuber, Richard A./Johnson, R. Stafford (2001): Searching for the favourite-longshot bias down under: An examination of the New Zealand pari-mutuel betting market, in: Applied Economics, Vol. 98, pp 1621-1629.

Golec, Joseph/Tamarkin, Maurry (1998): Bettors Love Skewness, Not Risk, at the Horse Track, in: Journal of Political Economy, Vol. 106, pp 205-225.

Gramm, Marshall (2005): Betting Market Efficiency at Premiere Racetracks, in: Southwestern Economic Review, Vol. 32, pp. 85-92.

Griffith, Richard M. (1949): Odds Adjustments by American Horse Race Bettors, in: American Journal of Psychology, Vol. 62, pp. 290-294.

Hausch, Donald B./Ziemba, William T. (1990): Arbitrage Strategies for Cross-Track Betting on Major Horse Races, in: Journal of Business, Vol. 63, pp. 61-78.

Hausch, Donald B./Ziemba, William T. (1995): Efficiency in Sports and Lottery Markets, in: Jarrow, Robert A./Maksimovic, Vojislav/Ziemba, William T. (Eds.): Finance - Handbooks in Operations Research and Management Science, Vol. 9, pp. 545-580.

Henery, Robert J. (1985): On the average Probability of losing Bets on Horses with given Starting Price Odds, in: Journal of the Royal Statistical Society, Vol. 148, pp. 342-349.

Johnson, Johnnie E./Bruce, Alistair C. (1993): Gluck’s Second Law: An empirical investigation of horserace betting in early and late races, in: Psychological Reports, Vol. 72, pp. 1251-1258.

Jullien, Bruno/Salanié, Bernard (2000): Estimating Preferences under Risk: The Case of Racetrack Bettors, in: Journal of Political Economy, Vol. 108, pp. 503-530.

Kahneman, Daniel/Tversky, Amos (1979): Prospect Theory: An Analysis of Decision under Risk, Econometrica, Vol. 47, pp. 263-292.

Kopelman, Richard E./Minkin, Betsy L. (1991): Toward a psychology of parimutuel behavior: test of Gluck's Law's, in: Psychological Reports, Vol. 68, pp. 701-702.

Law, David/Peel, David A. (2002): Insider Trading, Herding Behaviour and Market Plungers in the British Horse-race Betting Market, in: Economica, Vol. 69, pp. 327-338.

Markowitz, Harry (1952): The Utility of Wealth, in: Journal of Political Economy, Vol. 56, pp. 151-158.

Leong, Siew Meng/Lim, Kian Guan (1994): Cross-Track Betting: Is the Grass Greener on the Other Side? in: Hausch, Donald B./Lo, Victor S.Y./Ziemba, William T. (Eds.), Efficiency of Racetrack Betting Markets, San Diego, Academic Press, pp. 617-629.

McGlothlin, William H. (1956): Stability of Choices among Uncertain Alternatives, in: American Journal of Psychology, Vol. 69, pp. 604-616.

Quandt, Richard E. (1986): Betting and Equilibrium, in: Quarterly Journal of Economics, Vol. 101, pp. 201-207.

Sauer, Raymond D. (1998): The economics of wagering markets, in: Journal of Economic Literature, Vol. 36, pp. 2021-2064.

Schnytzer, Adi/Shilony, Yuval (1995): Inside Information in a betting market, in: Economic Journal, Vol. 105, pp. 963-971.

Schnytzer, Adi/Shilony, Yuval (2005): Insider trading and bias in a market for state contingent claims, in: Vaughan Williams, Leighton (Ed.), Information Efficiency in Financial and Betting Markets, Cambridge, Cambridge University Press, pp. 287-312.

Schnytzer, Adi/Shilony, Yuval/Thorpe, Richard (2003): On the marginal impact of information and arbitrage, in: Vaughan Williams, Leighton (Ed.), The Economics of Gambling, London and New York, Routledge, pp. 80-94.

Shin, Hyun Song (1991): Optimal betting odds against insider traders, in: Economic Journal, Vol. 101, pp. 1179-1185.

Shin, Hyun Song (1992): Prices of state contingent claims with insider traders, and the favourite-longshot bias, in: Economic Journal, Vol. 102, pp. 426-435.

Shin, Hyun Song (1993): Measuring the incidence of insider trading in a market for state-contingent claims. In: Economic Journal, Vol. 103, pp. 1141-1153.

Smith, Michael A./Paton, David/Vaughan Williams, Leighton (2006): Market Efficiency in Person-to-Person Betting, Economica, Vol. 73, pp. 673-689.

Snyder, Wayne W. (1978): Horse Racing: Testing the Efficient Markets Model, in: Journal of Finance, Vol. 33, pp. 1109-1118.

Snowberg, Erik/Wolfers, Justin (2006): Explaining the Favorite-Longshot Bias: Is it Risk-Love, or Misperceptions? In: Working Paper, available at http://cbdr.cmu.edu/seminar/Wolfers.pdf, download Feb. 13, 2007.

Sobel, Russel S./Raines, Travis (2003): An examination of the empirical derivatives of the favourite-longshot bias in racetrack betting, in: Applied Economics, Vol. 35. pp. 371-385.

Swidler, Steve/Shaw, Ron (1995): Racetrack Wagering and the "Uninformed" Bettor: A Study of Market Efficiency, in: Quarterly Review of Economics and Finance, Vol. 35, pp. 305-314.

Thaler, Richard H. (1985): Mental accounting and consumer choice, in: Marketing Science, Vol. 4, pp. 199-214.

Thaler, Richard H./Johnson, Eric J. (1990): Gambling with the house money and trying to break even: the effects of prior outcomes on risky choice, in: Management Science, Vol. 36, pp. 643-660.

Thaler, Richard H./Ziemba, William T. (1988): Parimutuel Betting Markets: Racetracks and Lotteries, in: Journal of Economic Perspectives, Vol. 2, pp. 161-174.

Tuckwell, R.H. (1983): The thoroughbred gambling market: efficiency, equity and related issues, in: Australian Economic Papers, June, pp. 106-118.

Tversky, Amos/Kahneman, Daniel (1992): Advances in Prospect Theory: Cumulative Representation of Uncertainty, in: Journal of Risk and Uncertainty, Vol. 5, pp. 297-324.

Vaughan Williams, Leighton/Paton, David (1997): Why is there a favourite-longshot bias in British racetrack betting markets? in: Economic Journal, Vol. 107, pp. 150-158.

Walls, W. David/Busche, Kelly (2003): Breakage, turnover and betting market efficiency: New evidence from Japanese horse tracks, in Vaughan Williams, Leighton (Ed.), The Economics of Gambling, London, Routledge.

Weitzman, Martin (1965): Utility Analysis and Group Behavior: An Empirical Study, in: Journal of Political Economy, Vol. 73, pp. 18-26.

Winter, Stefan/Kukuk, Martin (2006): Risk love and the favorite-longshot bias: Evidence from German Harness Horse Racing, in: Schmalenbachs Business Review, Vol. 58, pp 349-364.

Winter, Stefan/Kukuk, Martin (2008): Do horses like vodka and sponging? - On market manipulation and the favourite-longshot bias, in: Applied Economics, Vol. 40, pp 75-87.




DOI: http://dx.doi.org/10.5750/jgbe.v2i2.532

Refbacks

  • There are currently no refbacks.