Implications of Belief Distribution and Loss Aversion for Betting Market Anomalies

31 Pages Posted: 19 Feb 2021

See all articles by Dian Yu

Dian Yu

affiliation not provided to SSRN

Jianjun Gao

Shanghai University of Finance and Economics; Shanghai Jiao Tong University

Tongyao Wang

affiliation not provided to SSRN

Date Written: October 24, 2020

Abstract

The past several decades have witnessed a growing enthusiasm to implement the market as an information aggregation tool. However, some deep-rooted pricing anomalies frequently observed in various markets loom large, questioning the rationality of such eagerness. One of these anomalies is the favorite-longshot bias, and sometimes its opposite, the reverse favorite-longshot bias. We propose an equilibrium model consisting of traders with cumulative prospect theory-based utility and heterogeneous beliefs to explain these two anomalies in a unified framework. Unlike existing results that mostly focus on one aspect of the underlying model, our model enables us to isolate and analyze the impact of probability weighting, loss aversion, belief concentration, and belief tailedness. We show how these parameters jointly determine the property of the equilibrium price. Empirical results also suggest this model has adequate flexibility to explain the behavior of actual historical data.

Keywords: Forecasting; Belief aggregation; Market anomalies; Prediction markets; Prospect Theory

Suggested Citation

Yu, Dian and Gao, Jianjun and Wang, Tongyao, Implications of Belief Distribution and Loss Aversion for Betting Market Anomalies (October 24, 2020). Available at SSRN: https://ssrn.com/abstract=3718205

Dian Yu

affiliation not provided to SSRN

Jianjun Gao (Contact Author)

Shanghai University of Finance and Economics ( email )

No. 100 Wudong Road
Shanghai, Shanghai 200433
China

Shanghai Jiao Tong University ( email )

800 Dongchuan Road
Shanghai
China
+86-18201925139 (Phone)
+86 34205004 (Fax)

Tongyao Wang

affiliation not provided to SSRN

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