IDEAS home Printed from https://ideas.repec.org/a/eee/jfinec/v115y2015i3p486-504.html
   My bibliography  Save this article

Do investors overpay for stocks with lottery-like payoffs? An examination of the returns of OTC stocks

Author

Listed:
  • Eraker, Bjørn
  • Ready, Mark

Abstract

We study returns on over-the-counter stocks and find that these returns are extremely negative on average. The distribution of OTC stock returns is highly positively skewed: while many of the stocks in our sample become worthless, a few do extremely well. We investigate whether this negative return premium can be rationalized by investors׳ preference for positively skewed payoffs. We show that the equilibrium model of Barberis and Huang (2008) provides a plausible explanation for the negative returns. We also show that OTC stocks that once traded on the regular exchanges perform much better than stocks that originate in the OTC markets.

Suggested Citation

  • Eraker, Bjørn & Ready, Mark, 2015. "Do investors overpay for stocks with lottery-like payoffs? An examination of the returns of OTC stocks," Journal of Financial Economics, Elsevier, vol. 115(3), pages 486-504.
    • Handle: RePEc:eee:jfinec:v:115:y:2015:i:3:p:486-504
    DOI: 10.1016/j.jfineco.2014.11.002
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0304405X14002372
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jfineco.2014.11.002?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. John Y. Campbell & Martin Lettau & Burton G. Malkiel & Yexiao Xu, 2001. "Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk," Journal of Finance, American Finance Association, vol. 56(1), pages 1-43, February.
    2. Blume, Marshall E. & Stambaugh, Robert F., 1983. "Biases in computed returns : An application to the size effect," Journal of Financial Economics, Elsevier, vol. 12(3), pages 387-404, November.
    3. Pedro Bordalo & Nicola Gennaioli & Andrei Shleifer, 2012. "Salience Theory of Choice Under Risk," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 127(3), pages 1243-1285.
    4. Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 17(2), pages 223-249, December.
    5. Roll, Richard, 1983. "On computing mean returns and the small firm premium," Journal of Financial Economics, Elsevier, vol. 12(3), pages 371-386, November.
    6. Daniel Kahneman & Amos Tversky, 2013. "Prospect Theory: An Analysis of Decision Under Risk," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 6, pages 99-127, World Scientific Publishing Co. Pte. Ltd..
    7. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2006. "The Cross‐Section of Volatility and Expected Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 259-299, February.
    8. Erik Snowberg & Justin Wolfers, 2010. "Explaining the Favorite-Long Shot Bias: Is it Risk-Love or Misperceptions?," Journal of Political Economy, University of Chicago Press, vol. 118(4), pages 723-746, August.
    9. Alok Kumar, 2009. "Who Gambles in the Stock Market?," Journal of Finance, American Finance Association, vol. 64(4), pages 1889-1933, August.
    10. Campbell R. Harvey & Akhtar Siddique, 2000. "Conditional Skewness in Asset Pricing Tests," Journal of Finance, American Finance Association, vol. 55(3), pages 1263-1295, June.
    11. Bushee, Brian J. & Leuz, Christian, 2005. "Economic consequences of SEC disclosure regulation: evidence from the OTC bulletin board," Journal of Accounting and Economics, Elsevier, vol. 39(2), pages 233-264, June.
    12. Turan G. Bali & Nusret Cakici & Robert F. Whitelaw, 2009. "Maxing Out: Stocks as Lotteries and the Cross-Section of Expected Returns," NBER Working Papers 14804, National Bureau of Economic Research, Inc.
    13. N. Bhattacharya & T. A. Garrett, 2008. "Why people choose negative expected return assets - an empirical examination of a utility theoretic explanation," Applied Economics, Taylor & Francis Journals, vol. 40(1), pages 27-34.
    14. Francesca Cornelli & David Goldreich & Alexander Ljungqvist, 2006. "Investor Sentiment and Pre‐IPO Markets," Journal of Finance, American Finance Association, vol. 61(3), pages 1187-1216, June.
    15. Miller, Edward M, 1977. "Risk, Uncertainty, and Divergence of Opinion," Journal of Finance, American Finance Association, vol. 32(4), pages 1151-1168, September.
    16. Asparouhova, Elena & Bessembinder, Hendrik & Kalcheva, Ivalina, 2010. "Liquidity biases in asset pricing tests," Journal of Financial Economics, Elsevier, vol. 96(2), pages 215-237, May.
    17. Marshall Blume & Robert Stambaugh, "undated". "Biases in Computed Returns: An Application to the Size Effect (Revision of 2-83)," Rodney L. White Center for Financial Research Working Papers 11-83, Wharton School Rodney L. White Center for Financial Research.
    18. Joseph Golec & Maurry Tamarkin, 1998. "Bettors Love Skewness, Not Risk, at the Horse Track," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 205-225, February.
    19. Bollen, Nicolas P.B. & Christie, William G., 2009. "Market microstructure of the Pink Sheets," Journal of Banking & Finance, Elsevier, vol. 33(7), pages 1326-1339, July.
    20. Shumway, Tyler, 1997. "The Delisting Bias in CRSP Data," Journal of Finance, American Finance Association, vol. 52(1), pages 327-340, March.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Andrew Ang & Assaf A. Shtauber & Paul C. Tetlock, 2013. "Asset Pricing in the Dark: The Cross-Section of OTC Stocks," The Review of Financial Studies, Society for Financial Studies, vol. 26(12), pages 2985-3028.
    2. Lin, Chaonan & Chen, Hong-Yi & Ko, Kuan-Cheng & Yang, Nien-Tzu, 2021. "Time-dependent lottery preference and the cross-section of stock returns," Journal of Empirical Finance, Elsevier, vol. 64(C), pages 272-294.
    3. M. Reza Bradrania & Maurice Peat & Stephen Satchell, 2022. "Liquidity Costs, Idiosyncratic Volatility and Expected Stock Returns," Papers 2211.04695, arXiv.org.
    4. David Hirshleife, 2015. "Behavioral Finance," Annual Review of Financial Economics, Annual Reviews, vol. 7(1), pages 133-159, December.
    5. Huang, Wei & Liu, Qianqiu & Ghon Rhee, S. & Wu, Feng, 2012. "Extreme downside risk and expected stock returns," Journal of Banking & Finance, Elsevier, vol. 36(5), pages 1492-1502.
    6. Tariq Aziz & Valeed Ahmad Ansari, 2017. "Idiosyncratic volatility and stock returns: Indian evidence," Cogent Economics & Finance, Taylor & Francis Journals, vol. 5(1), pages 1420998-142, January.
    7. Hou, Kewei & Xue, Chen & Zhang, Lu, 2017. "Replicating Anomalies," Working Paper Series 2017-10, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    8. Gregory Connor & Lisa R. Goldberg & Robert A. Korajczyk, 2010. "Portfolio Risk Analysis," Economics Books, Princeton University Press, edition 1, number 9224.
    9. Thanh Huong Nguyen, 2019. "Information and Noise in Stock Markets: Evidence on the Determinants and Effects Using New Empirical Measures," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 7-2019.
    10. Jungshik Hur & Cedric Mbanga Luma, 2017. "Aggregate idiosyncratic volatility, dynamic aspects of loss aversion, and narrow framing," Review of Quantitative Finance and Accounting, Springer, vol. 49(2), pages 407-433, August.
    11. Zhong, Angel, 2018. "Idiosyncratic volatility in the Australian equity market," Pacific-Basin Finance Journal, Elsevier, vol. 50(C), pages 105-125.
    12. Avanidhar Subrahmanyam, 2010. "The Cross†Section of Expected Stock Returns: What Have We Learnt from the Past Twenty†Five Years of Research?," European Financial Management, European Financial Management Association, vol. 16(1), pages 27-42, January.
    13. Reza Bradrania, M. & Peat, Maurice & Satchell, Stephen, 2015. "Liquidity costs, idiosyncratic volatility and expected stock returns," International Review of Financial Analysis, Elsevier, vol. 42(C), pages 394-406.
    14. Hagströmer, Björn & Nilsson, Birger & Hansson, Björn, 2011. "The components of the illiquidity premium: An empirical analysis of U.S. stocks 1927-2010," Working Papers 2011:24, Lund University, Department of Economics.
    15. Jondeau, Eric & Zhang, Qunzi & Zhu, Xiaoneng, 2019. "Average skewness matters," Journal of Financial Economics, Elsevier, vol. 134(1), pages 29-47.
    16. Jin, Xiaoye, 2022. "Testing technical trading strategies on China's equity ETFs: A skewness perspective," Emerging Markets Review, Elsevier, vol. 51(PA).
    17. Davis, Ryan & Griffith, Todd & Van Ness, Bonnie & Van Ness, Robert, 2023. "Modern OTC market structure and liquidity: The tale of three tiers," Journal of Financial Markets, Elsevier, vol. 64(C).
    18. Wang, Huijun & Yan, Jinghua & Yu, Jianfeng, 2017. "Reference-dependent preferences and the risk–return trade-off," Journal of Financial Economics, Elsevier, vol. 123(2), pages 395-414.
    19. Goh, Jihoon & Jeong, Giho & Kang, Jangkoo, 2022. "The reference dependency of short-term reversal," International Review of Economics & Finance, Elsevier, vol. 78(C), pages 195-211.
    20. Konstantinidi, Theodosia, 2022. "Firm life cycle, expectation errors and future stock returns," Journal of Banking & Finance, Elsevier, vol. 143(C).

    More about this item

    Keywords

    Prospect theory; Skewness; Lottery stocks; OTCBB;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jfinec:v:115:y:2015:i:3:p:486-504. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/505576 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.