Since it is Sunday, it is time for sports, at least in the United States, I thought it would be an appropriate time to talk about markets based upon sports outcomes. People have been betting on sports for as long as there have been sports - I am sure that the ancient Romans had side-bets going on the gladiators. Today, sports betting is a multi-billion dollar business, though a big chunk of it is underground. In addition, we have markets like Tradesports.com (an online betting market), where you can bet on just about anything in the world, As with other markets, the question is whether the odds/prices you see in these markets are good predictors of success or failure.
Studies that have looked at sporting markets have uncovered some interesting evidence that gamblers bet too little on favorites and too much on long odds. As they lose money, they seem to increase their betting on longer odds. This has been attributed to a number of factors including a general tendency among humans to under estimate large probabilities (such as the likelihood that you will get sick) and over estimate small ones (say the odds of dying in an airline accident) and the craving for the excitement that comes from betting on long odds. Extending this finding to financial markets, this would lead to us to believe that deep out-of-the-money options and stocks in deeply distressed companies are likely to be over valued, since the long shot bias will push up their prices. Conversely, companies that are in boring and predictable businesses will be under priced like favorites.
Of course, all of the evidence from the sports betting market has to be taken with a grain of salt, since sports gamblers (at least the big ones) may be less risk averse than the rest of us. So, do what you will with that finding!! I am going back to watching my son play soccer (and no bets on that one)!!!