Erik Snowberg
California Institute of Technology - Division of the Humanities and Social Sciences
Justin Wolfers
University of Pennsylvania - Business & Public Policy Department; National Bureau of Economic Research (NBER); Institute for the Study of Labor (IZA); Centre for Economic Policy Research (CEPR); Federal Reserve Bank of San Francisco; CESifo (Center for Economic Studies and Ifo Institute for Economic Research); 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 favour of the view that misperceptions of probability drive the favorite-longshot bias, as suggested by Prospect Theory.
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