Levitt’s risky prize-seeking behavior
Mike Linksvayer December 30th, 2006
CFM already cited Steven Levitt’s Why Are Gambling Markets Organised So Differently From Financial Markets?, but it’s worth linking to again, if only to emphasize how different prediction markets are from most sports betting, and because Levitt just linked to a version of the paper with much nicer formatting.
Levitt’s Freakonomics post also provides a vivid illustration of how prizes for top players engenders risk-taking. Levitt knows that in order to have a small chance of winning a big prize he needs to bet on lower probability events in the final round.
Unfortunately for me, the payoff structure is highly skewed, with first place paying $70,000 and seventh place paying “only” $2,500. So I need a great last week to propel me up the standings.
Knowing the top bettors all pick lots of home underdogs, it means that this week I have no choice but to bet against home underdogs. I need to make sure my picks are as different as possible from the picks of the people in front of me. I gain a lot in dollars if I do much better than the people in front of me. If I do much worse, it doesn’t cost me much.
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As Leslie Fine noted, continuous payoffs are preferable.
The strategy of differentiating your bets in rank-order contests is described here:
http://faculty.london.edu/mottaviani/Gergaud.pdf
and more generally, here:
http://faculty.london.edu/mottaviani/fc.pdf