Abstract
The present study explores the effect of the gambler’s fallacy on stock trading volumes. I hypothesize that if a stock’s price rises (falls) during a number of consecutive trading days, then the gambler’s fallacy may cause at least some of the investors to expect that the stock’s price “has” to subsequently fall (rise), and thus, to increase their willingness to sell (buy) the stock, resulting in a stronger degree of disagreement between the investors and a higher-than-usual stock trading volume on the first day when the stock’s price indeed falls (rises). Employing a large sample of daily price and trading volume data, I document that following relatively long sequences of the same-sign stock returns, on the days when the sign is reversed, the trading activity in the respective stocks is abnormally high. Moreover, average abnormal trading volumes gradually and significantly increase with the length of the preceding return sequence. The effect is slightly more pronounced following the sequences of negative stock returns, and remains significant after controlling for other potentially influential factors, including contemporaneous and lagged actual and absolute stock returns, historical stock returns and volatilities, and company-specific events, such as earnings announcements and dividend payments.
Highlights
The major goal of any market, including the stock exchange, is to facilitate the trading activity in it
The strand of literature dealing with this link provides a wide range of important findings, indicating that absolute values of daily stock returns and contemporaneous trading volumes are positively correlated for both market indices and individual stocks (e.g., Westerfield 1977; Rutledge 1984; Karpoff 1987; Schwert 1989; Gallant et al 1992); there is a positive relationship between absolute values of daily stock returns and contemporaneous changes in trading volume (e.g., Crouch 1970; Epps and Epps 1976; Harris 1983; Pathirawasam 2011); trading volumes tend to be higher when the stock prices are rising (e.g., Campbell et al 1993; Saatccioglu and Starks 1998; Llorente et al 2002); and positive stock returns lead to higher subsequent trading volumes (e.g., Statman et al 2006; Griffin et al 2007; Glaser and Weber 2009)
I perform a simple calculation of abnormal trading volumes following sequences of days characterized by the same-sign stock returns
Summary
The major goal of any market, including the stock exchange, is to facilitate the trading activity in it. The previous studies identify several factors that may potentially give rise to the trading process, including portfolio rebalancing reasons (e.g., Hirshleifer et al 1994, 2006; Hong and Stein 1999; Chordia et al 2007), dispersion in investors’ expectations and different interpretations of information events and potential risks (e.g., Karpoff 1986, 1987; Kandel and Pearson 1995; Llorente et al 2002; Lo and Wang 2006), and presence of irrational traders (e.g., Baker and Stein 2004; Hong and Yu 2009) Another major empirical fact that is clearly stated by the previous financial literature is that there exists an imprescriptible link between stock prices and trading volumes.
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