Price formation in parimutuel markets : a thesis presented in partial fulfilment of the requirements for the degree of Master of Management in Economics at Massey University, Albany, New Zealand
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Date
2010
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Massey University
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Abstract
Two types of betting are common in sports betting: fixed odds betting and parimutuel
betting. In fixed odds betting, the payout conditional on winning is fixed once the
bet is placed and is not affected by the placing of subsequent bets. By contrast,
winning bettors in a parimutuel contest share pro-rata in the total betting pool.
This means that the payout to winning bettors in a parimutuel contest depends not
only on selecting the winning outcome, but also on the amounts bet by other bettors
(which cannot be observed at the time a bet is placed). Therefore a parimutuel contest
can be viewed as a game at the level of individual bettors. Existing models in
the parimutuel literature explain the data by either assuming a single, representative
bettor with certain risk preferences or by assuming that a number of risk neutral
bettors compete strategically within a game theoretic framework. Our contribution
is to construct a novel theoretical framework of parimutuel markets in which we
model both strategic interaction and risk preferences at the level of individual insiders,
in the presence of exogenous outsiders. We solve this model analytically for
the optimal insider betting amount in a static symmetric Nash equilibrium. Using
a new dataset of 1.6 million individual horse race bets in New Zealand from 2006 to
2009, we document a strong inverse linear relationship between our model-implied
insider risk preferences and the strength of insider beliefs relative to outsiders. That
is, as the strength of insiders’ beliefs relative to that of outsiders decrease, implied
risk sensitivity moves from risk averse to risk loving. At a level of insider beliefs
congruent with actual performance in the data, average implied risk preferences are
close to zero, that is, insiders are effectively risk neutral. While risk neutrality is
a standard assumption in strategic interaction models of parimutuel betting, our
study is the first to provide empirical support for this assumption. Finally, we document
a strong relationship (not previously reported in the literature) between the
average bet size and the average payout ratio, suggesting that bettors with inside
information self-select by placing larger bets.
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Keywords
Betting odds, Sports betting