Abstract
We use a unique data set from Finnish and Swedish horse race betting markets to explain the favorite-longshot bias. The data set includes a complete set of odds for exotic markets. We use the exotic market odds in conjunction with the win market odds and find convincing support for the misperceptions explanation of the favorite-longshot bias rather than the risk-love explanation. Furthermore, our data provide evidence of a specific type of failure to reduce compound lotteries. Namely, it seems that bettors do not assess the exotic market events as simple lotteries but instead consider the race for the first place and the race for the second place in a sequential form.
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Notes
Snowberg and Wolfers (2008) explicitly use this characterization.
In both countries, the monopolies face minor competition from internet betting sites that operate abroad.
For example, trifecta betting does not take place in all races.
We fit nonparametric as well as parametric constant absolute risk aversion utility functions by using the likelihood-based approach of Jullien and Salanie (2000) for both markets. The results display significantly (\( p < 0.0001 \) for parametric estimates) different utility functions across the markets.
We also fit a parametric Prelec weighting function for both markets by using the likelihood-based approach of Jullien and Salanie (2000). The estimates display significant (\( p < 0.0001 \)) nonlinearity in both markets. The weighting functions are also significantly (\( p < 0.0001 \)) different across the markets.
It is a well-known fact that the Harville formula is biased. This bias occurs because there tends to be more entropy in the race for second place than for first place. This makes favorites who fail to win less likely to finish second than implied by the Harville formula (see Stern 1990).
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We thank the anonymous referees for their useful suggestions.
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Koivuranta, M., Korhonen, M. Misperception explains favorite-longshot bias: evidence from the Finnish and Swedish harness horse race markets. Empir Econ 57, 2149–2160 (2019). https://doi.org/10.1007/s00181-018-1538-0
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DOI: https://doi.org/10.1007/s00181-018-1538-0