Investment lessons from the racetrack
One frequently discussed finding in the literature is the “favorite long-shot bias”. That is the fact that bettors value ‘long shots’, horses highly unlikely to win, more than they should, given how rarely they finish first. At the same time, they value safe bets too little, given how often they win. But is this phenomenon due to misperception of risk (overconfidence), or simply to risk-loving behavior?
This study* by Erik Snowberg and Justin Wolfers found that the former explanation is probably the main driver. By analogy, the low-volatility anomaly can also be framed as a long-shot bias on the equity market. From this perspective, the anomaly is not driven by risk-loving preferences, but by chronic overconfidence of investors.
*‘Explaining the Favorite-Longshot Bias: Is it Risk-Love or Misperceptions?’, Erik Snowberg and Justin Wolfer, NBER Working Paper No. 15923, 2010.
Our researchers publish many whitepapers based on their own empirical studies; they also follow quantitative research done by others.
