Working Paper: NBER ID: w15923
Authors: Erik Snowberg; Justin Wolfers
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.
Keywords: favorite-longshot bias; risk-love; misperceptions; horse racing; betting markets
JEL Codes: D03; D49; G13; G14; L83
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| misperceptions of probability (D80) | favorite-longshot bias (G41) |
| misperceptions class predicts prices of exotic bets more accurately than risk-love class (G41) | observed betting patterns (L83) |
| risk-love model (D81) | larger risk penalty for riskier bets (D81) |
| risk-love class (D81) | perverse negative correlation with actual betting results (L83) |
| misperceptions class yields predictions that align closely with observed outcomes (D80) | observed outcomes (C90) |