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Keywords:

  • horse betting;
  • bookmaking;
  • state-contingent claims

Abstract

This paper studies fixed odds bookmaking in the market for bets in a British horse race. The bookmaker faces the risk of unbalanced liability exposures. Even random shocks in the noisy betting demands are costly to the bookmaker since his book could become less balanced. In our model, the bookmaker sets appropriate odds to influence the betting flow to mitigate the risk. The stylised fact of the favourite-longshot bias only arises from the model under specific assumptions. Our model offers insights into the complexity of managing a series of state contingent exposures such as options.