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Maxing Out: Stocks as Lotteries and the Cross-Section of Expected Returns

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Author Info
Turan G. Bali
Nusret Cakici
Robert F. Whitelaw
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 documented in Ang et al. (2006, 2008).

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14804.

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Date of creation: Mar 2009
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Handle: RePEc:nbr:nberwo:14804

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G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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