Noise, Information, and the Favorite-Longshot Bias

Marco Ottaviani and Peter Norman Sørensen
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Peter Norman Sørensen: Department of Economics, University of Copenhagen

No 2006/04, FRU Working Papers from University of Copenhagen. Department of Economics. Finance Research Unit

Abstract: According to the favorite-longshot bias, longshots are overbet relative to favorites. We propose an explanation for this bias (and its reverse) based on an equilibrium model of informed betting in parimutuel markets. The bias arises because bettors take positions without knowing the positions simultaneously taken by other privately informed bettors. The direction and the extent of the bias depend on the amount of private information relative to noise present in the market. With realistic ex-post noise and ex-ante asymmetries, our model replicates the main qualitative features of expected returns observed in horse races.

Keywords: parimutuel betting; favorite-longshot bias; private information; noise; lotteries (search for similar items in EconPapers)
JEL-codes: D82 D83 D84 (search for similar items in EconPapers)
Pages: 25 pages
Date: 2006-05
New Economics Papers: this item is included in nep-fmk and nep-upt
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Related works:
Working Paper: Noise, Information and the Favorite-Longshot Bias (2005)
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