Abstract

This paper examines a game-theoretical model of parimutuel betting markets with asymmetric information. Generically, all Bayesian-Nash equilibria of the simultaneous game are characterized depending on the number of bettors and the quality of their private information. An equilibrium where all bettors use their private information always exists and becomes unique as the number of bettors increases. On the contrary, in a sequential framework, a perfectly revealing equilibrium does not always exist and disappears as the number of bettors increases. Bettors arbitrate between following their private signal, following the choices of previous bettors, and betting against the trend. On average, information is well aggregated by the market, but extreme effects based on herd and contrarian behavior occur in identifiable states of the world, leading to significant mispricing.

Citations