If aggregate volatility is a risk factor that is orthogonal to existing risk factors, the sensitivity of stocks. We extend and enrich the finding of a recent paper by bali, cakici, and whitelaw. Whitelawc february 2010 abstract motivated by existing evidence of a preference among investors for assets with lottery like payoffs and. April 2008 preliminary and incomplete abstract motivated by existing evidence of a preference among investors for assets with lotterylike payoffs and that. Stocks as lotteries and the crosssection of expected returns article in ssrn electronic journal january 2010 with 75 reads how we measure reads. Crosssection of expected returns and extreme returns. For full access to this pdf, sign in to an existing account, or purchase an annual. Investor attention, lottery stocks and the crosssection. Boyer, mitton and vorkink 2010 use a measure of expected idiosyncratic. Portfoliolevel analyses and firmlevel cross sectional regressions indicate a negative and significant relation between the maximum daily return over the past one month max and expected stock returns. Journal of financial economics volume 99, issue 2, february 2011, pages 427446 cover image maxing out. Pdf crash risk in individual stocks job market paper.
Stocks as lotteries and the cross section of expected returns. The beta anomaly is very strong among stocks with low institutional ownership and. The rational economic models in the mold of capm and apt have helped us understand the theoretical underpinnings of cross section of stock returns. Again, variation in max is apparently priced in the crosssection, with large return differences and corresponding tstatistics. Rather than attempting to tease out different aspects of the ex post data, we focus on the three factors value, quality e. Our supraview brings to light new facts about rps, including that more than 330 signals have been reported. In this study, i develop a novel methodology to extract crash risk premia from options and stock markets.
First, when the jackpot exceeds 500 million taiwan dollars about 15. Introduction there is a growing literature documenting a negative relationship between observed volatility and future stock returns. This study seeks to inform investment academics and practitioners by describing and analyzing the population of return predictive signals rps publicly identified over the 40year period 19702010. This cited by count includes citations to the following articles in scholar. Expected stock returns idiosyncratic return volatility cross section 1.
Georgetown university robert emmett mcdonough school of business, university of california, irvine paul merage school of business, city university of new york, baruch college zicklin school of business department of economics and finance and fordham university gabelli school of business. Out ofsample forecasts from fm regressions provide a simple, yet surprisingly effective, way to form a composite trading strategy going long high expected return stocks. Compared to other factors, low volatility is somewhat unique because there are two efficient ways to gain low volatility factor exposure. Stocks as lotteries and the cross section of expected returns, authorturan g. G12 abstract motivated by existing evidence of a preference among investors for assets with lottery like payoffs. Financial economists have long been engrossed with explaining the cross section of stock returns. These results are robust to controls for size, bookto market, momentum, shortterm reversals, liquidity, and. However, since that time, hundreds of papers have tried to explain the cross. Multiple natural experiments of large jackpot lotteries in taiwan are used to document that some individual investors trade stocks as a form of gambling. Crash sensitivity and the cross section of expected stock.
We find a consistently negative relationship between maximum daily stock returns over the past one month max and expected stock returns for three broad equity markets, namely the united states, europe and japan. Stocks as lotteries and the crosssection of expected returns, journal of financial economics, february 2011, 992, 427446 with nusret cakici and robert whitelaw. Over forty years ago, one of the first tests of the capital asset pricing model capm found that the market beta was a significant explanator of the crosssection of expected returns. Stocks as lotteries and the crosssection of expected returns motivated by existing evidence of a preference among investors for. Whitelawc,d,n a department of economics and finance, zicklin school of business, baruch college, one bernard baruch way, box 10225, new york, ny 10010, united states. Stocks as lotteries and the crosssection of expected returns by turan g. Crash sensitivity and the cross section of expected stock returns volume 53 issue 3 fousseni chabiyo, stefan ruenzi, florian weigert. Whitelawc,d,n a department of economics and finance, zicklin school of business, baruch college, one bernard baruch way, box 10225, new york, ny 10010, united states b department of finance, fordham university, fordham university, 1 west 60th street, new york, ny 10023. The cross section of expected stock returns 3 available at the time i. Pdf title do individual investors trade stocks as gambling. Average raw and riskadjusted return differences between stocks in the lowest and highest max deciles exceed 1% per month.
Hundreds of papers and hundreds of factors attempt to explain the cross section of expected returns. Motivated by existing evidence of a preference among investors for assets with lottery like payoffs and that many investors are poorly diversified, we investigate the significance of extreme. Amihud and yakov, 2002, illiquidity and stock returns. Stocks as lotteries and the crosssection of expected returns, authorturan g. Using the crosssection of stock returns also allows us to easily control for a battery of crosssectional effects, like the size and value factors of fama and french 1993, the momentum effect of jegadeesh and titman 1993, and the effect of liquidity risk documented by pastor and stambaugh 2003. Most of the low risk portfolios consists of growth and winner stocks. To the extent that market risk explains the cross section of expected returns, this relation between max and beta serves only to emphasize the low raw returns earned by the high max stocks as shown in table 1. Max as our main skewness measure because it presents a clear lotterylike feature that can. Stocks as lotteries and the cross section of expected returns by turan g. We examine the role of extreme positive returns in the crosssection of stock returns in seven countries. Thus, liquidity does not explain the negative relation between maximum daily returns and future stock returns. This paper o ers a rational explanation for why lottery like stocks have low expected returns by pointing out that such stocks tend to act as valuable insurance against unex.
Stocks as lotteries and the crosssection of expected. Whitelawxavier gabaix, daniel smith, jeff wurgler, seminar participants, turan g. I document a dramatic increase in crash risk premia after the 20082009 financial crisis, indicating that investors are willing to pay high insurance to hedge against crashes in individual stocks. The lottery demand phenomenon is attributable to individual, not institutional, investors. Ep is likely to be higher prices are lower relative to earnings for stocks with higher risks and expected returns, whatever the unnamed sources of risk. The difference in fourfactor alphas should control for this effect, which partially explains why this difference is larger than the. Stocks as lotteries and the crosssection of expected returns. Motivated by existing evidence of a preference among investors for assets with lottery like payoffs and that many investors are poorly diversified, we investigate the significance of extreme positive returns in the crosssectional pricing of stocks.
The crosssection of expected stock returns 429 also possible, however, that beme just captures the unraveling regression toward the mean of irrational market whims about the prospects of firms. Two easily measured variables, size me and bookto market equity. Stock market crosssectional skewness and business cycle. The crosssection of expected stock returns eugene f.
Portfoliolevel analyses and firmlevel crosssectional regressions indicate a. Maxing out stocks as lotteries and the crosssection of expected. Their findings revealed that extreme positive returns measured by maximum daily returns in the previous month max had a significantly negative relationship with expected stock returns in the u. Balia, 1, email the corresponding author, nusret cakicib, 2, email the corresponding author, robert f. Graduate school of business, university of chicago, 1101 east 58th street, chicago, il 60637. Crash sensitivity and the cross section of expected stock returns. Stocks as lotteries and the crosssection of expected returns turan g. Crash aversion and the crosssection of expected stock returns. Stocks as lotteries and the crosssection of expected returns motivated by existing evidence of a preference among investors for assets with lottery like payoffs and. The crosssection of volatility and expected returns. Stocks as lotteries and the cross section of expected returns turan g.
This substitution effect between lottery and stock is substantiated by the following five key findings. Those investors substitute lottery gambling for stock trading. Crosssection of volatility and expected returns 261 of assets that may have different exposures to aggregate volatility and hence different average returns. We acknowledge the helpful comments of david booth, nai. Idiosyncratic risk and the crosssection of expected stock returns. Stocks as lotteries and the cross section of expected returns, journal of financial economics, february 2011, 992, 427446 with nusret cakici and robert whitelaw.
Ball 1978 argues that ep is a catchall proxy for unnamed factors in expected returns. Stocks as lotteries and the cross section of expected returns, nber working papers 14804, national bureau of economic research, inc. Stocks as lotteries and the crosssection of expected returns turan g bali. Skewness, individual investor preference, and the crosssection of. Given this extensive data mining, it does not make any economic or statistical sense to use the usual significance criteria for a newly discovered factor, e. Portfoliolevel analyses and firmlevel crosssectional regressions indicate a negative and significant relation between the maximum daily return over the past one month max and expected stock returns. The negative relation between idiosyncratic volatility and expected returns, or idiosyncratic volatility puzzle, exists only for stocks with high max, implying that the puzzle may arise from the overpayment for stocks with high max and the subsequent return reversal. The cross section of cashflow volatility and expected. The interpretation given was that lessdiversified investors who.
Their combined citations are counted only for the first article. The excess returns are the highest for low risk portfolio sorted for volatility of large cap stocks. Idiosyncratic volatility and the cross section of expected returns. Unusual news events and the crosssection of stock returns. These results are robust to controls for size, bookto market, momentum, shortterm reversals, liquidity, and skewness. Portfoliolevel analyses and firmlevel crosssectional regressions indicate a negative and significant relation between the maximum.
Asset pricing motivated by existing evidence of a preference among investors for assets with lottery like payoffs and that many investors are poorly diversified, we investigate the significance of extreme. After controlling for max, there is a positive and statistically signi. Returns to low risk investment strategy applied finance letters. In this study, we use a multifactor approach to identify stocks with positively skewed expected returns. In conclusion, the low risk portfolio investment strategy is independent of size and gives positive excess returns as compared to high risk portfolio in the indian stock market. Hence, stocks with different sensitivities to innovations in aggregate volatility should have different expected returns. Motivated by existing evidence of a preference among investors for assets with lotterylike payoffs and that many investors are poorly diversified, we investigate the significance of extreme positive returns in the cross sectional pricing of stocks. Out of sample forecasts from fm regressions provide a simple, yet surprisingly effective, way to form a composite trading strategy going long high expected return stocks. This finding generally confirms but is weaker than earlier evidence by bali, cakici and whitelaw 2011. The supraview of return predictive signals springerlink.
The relationship between return and market value of common stocks. April 2008 preliminary and incomplete abstract motivated by existing evidence of a preference among investors for assets with lottery like payoffs and that. Portfoliolevel analyses and firmlevel cross sectional regressions indicate a negative and significant relation between the maximum daily return over the past one monthmax and expected stock returns. Whatever the underlying economic causes, our main result is straightfor ward. Both approaches show that high rtp stocks have significantly lower average returns. G12 abstract motivated by existing evidence of a preference among investors for assets with lotterylike payoffs. We use daily stock returns to calculate the maximum daily stock return for each firm in each month as well as such variables as the market beta, idiosyncratic. The crosssection of expected stock returns 3 available at the time i. Motivated by existing evidence of a preference among investors for assets with lottery like payoffs and that many investors are poorly diversified, we investigate the significance of.