The Behavioral Science of Overbetting the Longshots

Last Friday I had an entertaining conversation. At some point, we were talking about investing in shitcoin. This got me thinking of why people invest capital in things with a tiny chance of a large payoff.
 
The favorite–longshot bias describes a long-standing empirical regularity. In horseracing, for example, people often underbet the favorites (horses with the best odds of winning) and overbet the longshots (horses with worse odds of winning).
 
According to behavioral science, the possible explanation of this phenomenon has to do less with risk-love, but more with misperceptions of probabilities. The difference between 0% and 1% (also between 99% and 100%) is much more salient than that between 10% and 11%.
 
As a result, we tend to overreact to small changes in extreme probabilities and underreact to changes in intermediate probabilities. We will pay far more for a medical operation that increases our chance of surviving from 0% to 1% than one that increases it from 10% to 11%.
 
Similarly, we like to invest capital in things that have a chance of winning between 0% and 1%. Even an astronomical chance of winning is still a non-zero chance, and we tend to overreact to it (and overbet the longshots).
 
Takeaway: Beware of extreme probabilities and their effect on your decision-making.

Practice. Dream.
Lachezar