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

30 Pages Posted: 26 Apr 2010

See all articles by Erik C. Snowberg

Erik C. Snowberg

Independent

Justin Wolfers

University of Michigan at Ann Arbor - Department of Economics; University of Michigan at Ann Arbor - Gerald R. Ford School of Public Policy; The University of Sydney - Discipline of Economics; Brookings Institution - Economic Studies Program; Peter G. Peterson Institute for International Economics; National Bureau of Economic Research (NBER); IZA Institute of Labor Economics; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute); Kiel Institute for the World Economy

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: pricing under risk, probability weighting, compound lotteries, favorite-longshot bias

JEL Classification: D03, D49, G12, L83

Suggested Citation

Snowberg, Erik C. and Wolfers, Justin, Explaining the Favorite-Longshot Bias: Is it Risk-Love or Misperceptions?. IZA Discussion Paper No. 4884, Available at SSRN: https://ssrn.com/abstract=1595525

Justin Wolfers

University of Michigan at Ann Arbor - Department of Economics ( email )

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