A
Comparison of Discounted Corporate Bonds
and PariMutuel Horse Betting; and A Normative
Experiment On Convergence Through Internet
Publication of Bond Market Odds.
By Paul Scheurer © 2000 OUTLINE
0. "You can never know the outcome, but
you can know the odds."  Sir Humphries
Davy (17781829)
1. Significance of Odds vs. Probability
%.
(a) at racetrack,
defines both "ex ante" probability and "ex
post" payoff as 10to1 payoff means 1outof10
probability.
(b) all uncertainty
or ambiguity is subsumed in odds, for all
outcomes (win/lose) are perfectly foreseeable.
(c) efficient
under Samuelson's (1965) definition: "market
quotation ... already contains ... all that
can be known about the
future ...."
2. Bonds vs. Racetracks
(a) both efficient
markets of risk (Blum, et al, 1991; Ziemba
and Hausch, 1987).
(b) 90% of
time, race won by one of top 3 horses by
odds on tote board (Scott, 1981, Ziemba)
(c) "the bond
market is dominated by conservative investors
who keep rather close tabs on a company's
ability to repay the
principal." (Peter Lynch, 1994)
(d) bond spreads
(rrf) widen well before an S&P/Moody's
rating change (Weinstein, 1977)
(e) racetrack
passive strategy: bet on one of top 3 horses
ranked by odds (Scott, 1981, Ian Fleming,
1956)
3. Normative Experiment
(a) 1895 MN
Legislation  state grain inspector and
1 cent/year for weekly postcard to farmers
on prices in Minneapolis and
Duluth grain markets
(b) choice
of formulas (show)
(c) even though
CML with slope 1, still on contract curve
of Edgeworth box
(d) average
YTM of top 3 bonds (lowest YTM) across bond
rating and S.I.C.  so CML with slope 1(x)
as proxy for bond market
odds.
(e) Law of
Gas Stations ("Law of One Price" in economics)
is then applied to bond market
