Economic thought and model building traditionally stipulated the premise that individuals approach their decisions rationally by maximizing personal utility, like automatons calculating the best outcomes. Then, the empirical work of two Israeli psychologists, Daniel Kahneman and Amos Tversky, challenged this view and the fields of behavioral economics and behavioral finance were born. Kahneman won the Nobel Memorial Prize in Economic Sciences in 2002 for his work and Tversky would likely have done the same had he not died (the winner must be living). In 2017, a proponent of the Kahneman/Tversky approach, Richard Thaler, also won the Nobel Prize for integrating economics with psychology in human decision making.
Kahneman’s contribution was explained in part by the Nobel Society:
“One could call Daniel Kahneman the unicorn of economics. As a psychologist, he had a profound influence on people who criticized the homo economicus (the theoretical notion that our economic decisions are always perfectly rational), instead showing how people actually make decisions. His insights forever changed the field, paving the way for what’s now called behavioral economics.”
From time to time, Horse Racing Business will examine concepts from behavioral finance within the context of wagering on horse racing. Today’s article considers the rudimentary idea assumed by conventional economic models that decisions made by individuals are “transitive.” That is, in making choices, if A is preferred to B and B is preferred to C, then A should be preferred to C.
For simplification, suppose an experienced bettor, Alex, is looking at an upcoming three-entry race, a $16,000 claiming race for colts and geldings 4-years-old and up. Further, assume Alex has all the public information (published past performances) at his or her disposal.
Without taking odds into account, Alex thinks the three horses should finish in the following order:
White Lightening, Power Play, and Game Changer.
In other words, all else being equal, White Lightening has a better chance to win than Power Play and Game Changer, and Power Play should beat Game Changer.
But all things are not equal because the horses have different odds. White Lightening is 4/5, Power Play is 3/1, and Game Changer is 10/1.
Alex decides to place a straight exacta bet with Power Play over Game Changer.
Another individual, Bob, has never been to a racetrack before and knows nothing about deciphering past performances or handicapping. After a friend explains what an exacta is, Bob glances at the horses without consulting even the program and elects to make the identical bet as Alex. His friend makes the bet because neophyte Bob doesn’t know how to do so.
Does this exacta bet violate the principle of transivity? Horse B is preferred to Horse C (and bet that way) but both B and C are preferred to Horse A (and bet accordingly). Have Alex and Bob made irrational decisions?
This question will be discussed in a Sunday post (February 25th) on Horse Racing Business.
Copyright © 2018 Horse Racing Business
Depends on what odds Alex and Bob would give the horses. Giving them an expected order of finish is not enough information. There is an information gap between order of finish and specific odds for each person betting. Once you have elicited the odds in their minds, you can calculate their expected outcomes and therefore their bets. There is also the factor of being at a racetrack and wanting to participate. People at the races do not always refrain from betting when they expect to win less than the cost of their bet. And putting a win bet on an odds-on horse is boring. So there is inherent value in participating, but this value is qualitatively different from money.