Abstract
One of the most striking empirical patterns of horse race betting markets is the favorite-longshot bias: Bets on favorites have dramatically higher expected returns than bets on longshots. The literature offers a couple of different, though not mutually exclusive, explanations. One is the assumption of rational, risk-loving bettors accepting lower expected returns for longshot bets in exchange for higher risk. Another class of explanations focuses on information problems and misperceptions regarding winning probabilities. This article offers still another explanation: The favourite-longshot bias may be the rational answer of an honest audience to a simple, but highly lucrative cheating opportunity of insiders.
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