Pari mutuel wagering

[TERM] – Pari mutuel wagering

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[RELATED_TERM] = Fixed-odds betting
[TERM_CATEGORY] = Financial markets

What Is Pari-Mutuel Wagering?

Pari-mutuel wagering is a betting system in which all wagers of a particular type are placed together in a common pool. The total amount of money in this pool, after deductions for taxes and the operating commission (known as the "house-take" or vigorish), is then divided proportionally among all winning bettors. This system is primarily associated with forms of gambling where participants finish in a ranked order, such as horse racing, greyhound racing, and jai alai. Within the broader category of financial markets, pari-mutuel wagering operates distinctly from other forms of betting by allowing the payout odds to fluctuate based on the total amount wagered on each outcome, rather than being fixed at the time the bet is placed.

Pari-mutuel wagering ensures that the operator always earns a profit, as their commission is deducted before payouts are made. ⁴⁰The concept is often referred to as "pool betting" and is calculated and displayed by a specialized system known as a totalisator, or "tote board".

History and Origin

The pari-mutuel system was invented by French entrepreneur Joseph Oller in 1867. Oller, also known as the founder of the famous Moulin Rouge, initially conceived of a sweepstakes game based on horse racing results in 1862. ³⁸, ³⁹This early system involved randomly assigning horses to bettors, which was illegal in France at the time due to prohibitions on lotteries. To circumvent this, Oller refined his system, allowing bettors to choose their desired horses, leading to the creation of what he termed "Paris Mutuels".
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The large volume of calculations required for this system prompted the invention of the totalisator by Australian engineer George Alfred Julius. The first totalisator was installed at Ellerslie Racecourse in Auckland, New Zealand, in 1913, and these machines subsequently gained widespread adoption at racetracks globally. ³⁵Pari-mutuel wagering was introduced in the United States around 1927, with the first system installed at Arlington Park near Chicago.
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Key Takeaways

• Pari-mutuel wagering involves pooling all bets of a specific type, with winners sharing the net pool after deductions.
• Payout odds in pari-mutuel systems are not fixed; they are determined by the collective amount wagered on each outcome and are only finalized after all bets are placed and the pool closes.
• The system ensures a guaranteed commission for the operator, as a percentage is deducted from the total pool before distribution to winners.
  ³³* It is most commonly used in sports like horse racing, where participants finish in a ranked order.
• The "totalisator" is the specialized machine or computer system that calculates and displays the constantly changing odds and eventual payouts in pari-mutuel wagering.
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Formula and Calculation

In pari-mutuel wagering, the payoff for a winning bet is determined by the total money wagered on all outcomes, minus the house's commission and taxes, divided by the total money wagered on the winning outcome.

The formula for calculating the payout for a winning bet in a simple win pool can be expressed as:

Where:

• Total Pool: The sum of all money wagered on all possible outcomes in a specific betting category (e.g., win, place, or show).
  ³¹* Commission and Taxes: A predetermined percentage of the total pool deducted by the operating entity and applicable government taxes. ²⁹, ³⁰This percentage is often referred to as the "take-out rate".
• Total Wagered on Winning Outcome: The sum of all money placed by bettors on the outcome that ultimately wins the event.

For example, if the total pool for a "win" bet is $10,000, the commission and taxes are 15% ($1,500), and $2,000 was wagered on the winning horse, the amount available for distribution to winning bettors would be $8,500. The payout per dollar wagered on the winning horse would be:

Therefore, for every dollar wagered on the winning horse, a bettor would receive $4.25 back, including their initial dollar stake. This means a $2 bet would return $8.50. The fluctuating nature of the odds means that the effective dividend for each winning dollar only becomes clear once the betting window closes and the event begins. This is a key difference when compared to predetermined odds in other forms of betting.

Interpreting the Pari-Mutuel Wagering

Interpreting pari-mutuel wagering involves understanding that the odds presented before an event are dynamic and reflect the collective sentiment of all bettors rather than a bookmaker's assessment. These odds are essentially an indication of how much money has been wagered on each participant relative to the total pool. As more money is placed on a particular outcome, its odds will decrease, reflecting a higher perceived probability of winning and a lower potential payout. ²⁸Conversely, if less money is wagered on an outcome, its odds will lengthen, indicating a lower perceived probability but a higher potential return.

For a bettor, understanding these constantly shifting odds is crucial. The odds displayed on a tote board provide real-time insight into public betting patterns, allowing individuals to gauge which participants are favored or overlooked. While the initial "morning line" odds may provide a starting point, the final odds and payouts are only locked in when the betting period closes and the pool is finalized. ²⁷This means that the implied probability of a given outcome changes right up until the start of the event. Investors often compare this dynamic to market sentiment influencing stock prices, where a security's price reflects the aggregate opinion of all market participants at any given time.

Hypothetical Example

Consider a hypothetical horse race with three horses: Alpha, Beta, and Gamma. A total of $1,000 has been wagered on the race through pari-mutuel wagering.

Here's how the wagers break down:

• Alpha: $500 wagered
• Beta: $300 wagered
• Gamma: $200 wagered

The racetrack, as the operator, takes a commission of 18% from the total pool.

1. Calculate the total pool: $500 (Alpha) + $300 (Beta) + $200 (Gamma) = $1,000.
2. Calculate the commission: 18% of $1,000 = $180.
3. Calculate the net pool for distribution: $1,000 - $180 = $820.

Now, let's say Horse Alpha wins the race. The $820 net pool is divided among those who bet on Alpha.

4. Calculate the payout per dollar for Alpha: $820 (Net Pool) / $500 (Wagered on Alpha) = $1.64 per dollar wagered.

This means if a bettor placed a $2 wager on Alpha, they would receive $3.28 back ($1.64 x 2), including their original stake. Had Gamma, the longshot, won, the payout would have been much higher, as the $820 net pool would be divided by only $200 wagered on Gamma, resulting in $4.10 per dollar wagered. This example illustrates how the collective betting behavior directly determines the payout odds in a pari-mutuel system, providing a real-time risk assessment for participants.

Practical Applications

Pari-mutuel wagering is most prominently used in the realm of sporting events where participants are ranked, primarily horse racing, greyhound racing, and jai alai. Beyond traditional betting venues, modified pari-mutuel systems are also employed in certain lottery games.

The regulatory framework for pari-mutuel wagering in the United States often involves state-level racing and gaming commissions, such as those in Kansas and Maryland, which oversee licensing, operations, and the deduction of commissions. ²⁵, ²⁶The Interstate Horseracing Act of 1978 also governs interstate pari-mutuel wagering, regulating how wagers are accepted across state lines. ²³, ²⁴This legislation highlights the significant economic impact of the industry, which provides employment opportunities and generates tax revenue for states.

Limitations and Criticisms

One notable characteristic of pari-mutuel wagering is the "favorite-longshot bias," which suggests that favorites often win more frequently than their implied odds suggest, while longshots win less often. ²¹, ²²This means that the expected return for betting on favorites tends to be higher than for betting on longshots. ²⁰This bias has been a subject of academic study, with some research suggesting it may stem from bettors deriving greater utility from the excitement of betting on longshots, or from psychological biases such as "recency bias" or "hot-hand bias".
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Another limitation is the uncertainty of final payouts. Unlike fixed-odds betting, where the payout is known at the time of the bet, in pari-mutuel wagering, the exact return per dollar wagered is not determined until the betting pool closes. This fluctuating nature means that late wagers can significantly alter the odds and reduce potential returns for early bettors, making real-time arbitrage strategies difficult to execute profitably. ¹⁷While some academic models explore profitable betting strategies in pari-mutuel markets, consistently generating substantial returns proves challenging due to these last-minute shifts and the inherent market efficiency, where new information is quickly incorporated into the odds.
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Pari-Mutuel Wagering vs. Fixed-Odds Betting

Pari-mutuel wagering and fixed-odds betting represent two fundamental approaches to gambling, differing primarily in how payout odds are determined and when they are finalized.

The primary point of confusion between the two often lies in the dynamic nature of pari-mutuel payouts versus the static nature of fixed-odds payouts. In fixed-odds betting, a bettor knows precisely how much they stand to win at the moment they place their wager. ⁸Conversely, with pari-mutuel wagering, the exact winnings are uncertain until all bets are in and the event commences, as the final payout is a function of the total money in the pool and the proportion wagered on the winning outcome.

FAQs

What does "pari-mutuel" mean?

"Pari-mutuel" is French for "mutual stake" or "betting among ourselves". ⁶, ⁷It refers to a system where bettors pool their money, and the winners share the pool.

How are the odds determined in pari-mutuel wagering?

The odds are determined by the proportion of the total money wagered on each participant. If more money is bet on a particular outcome, its odds will decrease, reflecting a higher chance of winning according to the collective bettors, and a lower payout. Conversely, less money means higher odds and a larger potential payout.

Is pari-mutuel wagering legal in the United States?

Yes, pari-mutuel wagering is legal in many states within the U.S., particularly for horse racing. It is regulated at the state level by various racing and gaming commissions.
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What is the "take-out" in pari-mutuel wagering?

The "take-out" is the percentage of the total betting pool that is deducted by the racetrack or operating entity, along with any applicable taxes, before the remaining money is distributed to the winning bettors. ³This ensures the operator always makes a profit.

Can you make a guaranteed profit with pari-mutuel wagering?

No, there is no guaranteed profit in pari-mutuel wagering. While some academic research explores market efficiencies and betting strategies, the dynamic nature of the odds, combined with the inherent unpredictability of sporting events and the operator's take-out, means that consistent, risk-free profits are not assured.¹, ²