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Maxing out: Stocks as lotteries and the cross-section of expected returns

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  • Bali, Turan G.
  • Cakici, Nusret
  • Whitelaw, Robert F.
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    Abstract

    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 cross-sectional pricing of stocks. Portfolio-level analyses and firm-level cross-sectional regressions indicate a negative and significant relation between the maximum daily return over the past one month (MAX) and expected stock returns. Average raw and risk-adjusted return differences between stocks in the lowest and highest MAX deciles exceed 1% per month. These results are robust to controls for size, book-to-market, momentum, short-term reversals, liquidity, and skewness. Of particular interest, including MAX reverses the puzzling negative relation between returns and idiosyncratic volatility recently shown in (Ang et al., 2006) and (Ang et al., 2009).

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 99 (2011)
    Issue (Month): 2 (February)
    Pages: 427-446

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    Handle: RePEc:eee:jfinec:v:99:y:2011:i:2:p:427-446

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    Web page: http://www.elsevier.com/locate/inca/505576

    Related research

    Keywords: Extreme returns Lottery-like payoffs Cross-sectional return predictability Skewness preference Idiosyncratic volatility;

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    Cited by:
    1. Nicholas C. Barberis, 2013. "Thirty Years of Prospect Theory in Economics: A Review and Assessment," Journal of Economic Perspectives, American Economic Association, vol. 27(1), pages 173-96, Winter.
    2. Frazzini, Andrea & Pedersen, Lasse Heje, 2014. "Betting against beta," Journal of Financial Economics, Elsevier, vol. 111(1), pages 1-25.
    3. Walkshäusl, Christian, 2013. "The high returns to low volatility stocks are actually a premium on high quality firms," Review of Financial Economics, Elsevier, vol. 22(4), pages 180-186.
    4. Nartea, Gilbert V. & Wu, Ji, 2013. "Is there a volatility effect in the Hong Kong stock market?," Pacific-Basin Finance Journal, Elsevier, vol. 25(C), pages 119-135.
    5. Turan G. Bali & Lin Peng & Yannan Shen & Yi Tang, 2013. "Liquidity Shocks and Stock Market Reactions," Koç University-TUSIAD Economic Research Forum Working Papers 1304, Koc University-TUSIAD Economic Research Forum.
    6. Malcolm Baker & Jeffrey Wurgler, 2013. "Do Strict Capital Requirements Raise the Cost of Capital? Banking Regulation and the Low Risk Anomaly," NBER Working Papers 19018, National Bureau of Economic Research, Inc.
    7. Ruenzi, Stefan & Ungeheuer, Michael & Weigert, Florian, 2012. "Extreme Downside Liquidity Risk," Working Papers on Finance 1326, University of St. Gallen, School of Finance, revised Nov 2013.
    8. Nicholas C. Barberis, 2012. "Thirty Years of Prospect Theory in Economics: A Review and Assessment," NBER Working Papers 18621, National Bureau of Economic Research, Inc.
    9. Greenwood, Robin & Thesmar, David, 2011. "Stock price fragility," Journal of Financial Economics, Elsevier, vol. 102(3), pages 471-490.
    10. Yang, Chunpeng & Yan, Wei & Zhang, Rengui, 2013. "Sentiment approach to negative expected return in the stock market," Economic Modelling, Elsevier, vol. 35(C), pages 30-34.
    11. Ruenzi, Stefan & Weigert, Florian, 2011. "Crash Sensitivity and the Cross-Section of Expected Stock Returns," Working Papers on Finance 1324, University of St. Gallen, School of Finance, revised Mar 2013.
    12. ANNAERT, Jan & DE CEUSTER, Marc & VERSTEGEN, Kurt, 2012. "Are extreme returns priced in the stock market? European evidence," Working Papers 2012018, University of Antwerp, Faculty of Applied Economics.
    13. Robert F. Stambaugh & Jianfeng Yu & Yu Yuan, 2012. "Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle," NBER Working Papers 18560, National Bureau of Economic Research, Inc.
    14. Huffman, Stephen P. & Moll, Cliff R., 2013. "An examination of the relation between asymmetric risk measures, prior returns and expected daily stock returns," Review of Financial Economics, Elsevier, vol. 22(1), pages 8-19.
    15. Adelina Gschwandtner & Michael Hauser, 2013. "Profit Persistence and Stock Returns," Studies in Economics 1320, Department of Economics, University of Kent.
    16. Turan G. Bali & Robert F. Engle & Yi Tang, 2013. "Dynamic Conditional Beta is Alive and Well in the Cross-Section of Daily Stock Returns," Koç University-TUSIAD Economic Research Forum Working Papers 1305, Koc University-TUSIAD Economic Research Forum.
    17. Itamar Drechsler & Qingyi Freda Drechsler, 2014. "The Shorting Premium and Asset Pricing Anomalies," NBER Working Papers 20282, National Bureau of Economic Research, Inc.
    18. Elyès Jouini & Paul Karehnke & Clotilde Napp, 2013. "On Portfolio Choice with Savoring and Disappointment," Post-Print halshs-00927267, HAL.
    19. René Garcia & Daniel Mantilla-Garcia & Lionel Martellini, 2013. "A Model-Free Measure of Aggregate Idiosyncratic Volatility and the Prediction of Market Returns," CIRANO Working Papers 2013s-01, CIRANO.
    20. Foster, Jarred & Krawczyk, Jacek B, 2013. "Sensitivity of cautious-relaxed investment policies to target variation," Working Paper Series 2972, Victoria University of Wellington, School of Economics and Finance.
    21. Patrick Roger & Marie-Hélène Broihanne & Maxime Merli, 2012. "In search of positive skewness: the case of individual investors," Working Papers of LaRGE Research Center 2012-04, Laboratoire de Recherche en Gestion et Economie (LaRGE), Université de Strasbourg.
    22. Walkshäusl, Christian, 2014. "The MAX effect: European evidence," Journal of Banking & Finance, Elsevier, vol. 42(C), pages 1-10.
    23. Annaert, Jan & De Ceuster, Marc & Verstegen, Kurt, 2013. "Are extreme returns priced in the stock market? European evidence," Journal of Banking & Finance, Elsevier, vol. 37(9), pages 3401-3411.
    24. Chabi-Yo, Fousseni, 2011. "Explaining the idiosyncratic volatility puzzle using Stochastic Discount Factors," Journal of Banking & Finance, Elsevier, vol. 35(8), pages 1971-1983, August.
    25. Turan G. Bali & Nusret Cakici & Robert F. Whitelaw, 2013. "Hybrid Tail Risk and Expected Stock Returns: When Does the Tail Wag the Dog?," NBER Working Papers 19460, National Bureau of Economic Research, Inc.

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