An Exploration of Inefficiency in Market for State Contingent Claims.

This paper apportions responsability for inefficency in a market for state contingent claims between market makers and traders. We specifically examine the origins of a frequently observed distortion in the market for bets in horseraces- the favorite- longshot bias. Previous studies rationalise the bias in terms of traders' (bettors) or market makers' (bookmakers) behaviour. Employing hitherto unavailable data we conduct a parallel logistic analysis of parimutuel and bookmakers markets, which offers an uniquivocal basis for identifying the origin of the bias.