Lottery Preferences Research Articles

Asset pricing when social preference meets lottery preference: Evidence from China

There is substantial evidence indicating that stocks with lottery-like payoffs have lower returns. Unlike existing studies that focus on the role of investor behavior in accelerating lottery premiums, we propose that investors’ social preference toward corporate social responsibility (CSR) could alleviate the underperformance of lottery-like stocks. Using a sample of all Chinese listed A-share stocks, we show that a negative relationship between lottery preference and stock returns does not exist among stocks that behave well regarding CSR performance. Furthermore, we show that better CSR performance and higher institutional ownership mitigate the overpricing of lottery-like stocks. Our research contributes to CSR literature by showing that behaving socially responsible can prevent stock prices from being overpriced when the stock exhibits lottery-like payoffs.

Firm-level productivity and stock return: New evidence from China

This study provides novel insights into the stock return predictability related to the firm-level total factor productivity (TFP) in the China's stock market, covering the period from 1999 to 2020. Contrary to studies on other countries, our research identifies a positive correlation between the productivity of Chinese firms and their future stock returns. We suggest that this correlation is driven by mispricing rather than risk premium. Specifically, we argue that investors' difficulties in accurately assessing firm-level productivity and limited attention result in the inadequate incorporation of this information into stock prices. Furthermore, our analysis explores additional factors contributing to the observed productivity-related market anomaly, including investor overconfidence, positive feedback trading, lottery preference, information uncertainty, and limits to arbitrage, indicating investors' irrationality and behavioral biases. Importantly, our study also demonstrates that firm-level productivity serves as a reliable predictor of a firm's future profitability.

Bank affiliation and lottery-like characteristics of mutual funds

This study investigates the impact of commercial bank affiliation on mutual funds' lottery-like characteristics. Existing literature has extensively explored the benefits or costs of commercial bank affiliation in the asset management industry. Using a sample of Chinese mutual funds between 2003 and 2019, we reveal that bank affiliation significantly decreases these characteristics, and this phenomenon exhibits better performance. Our evidence suggests that affiliated funds benefit from information advantages. Notably, affiliated funds attract cash inflows by enhancing their performance rather than catering to investors’ lottery preferences. These results emphasize the role of gambling behavior in the mutual fund industry by focusing on the significance of ownership, in this case, by commercial banks.

The change in salience and the cross-section of stock returns: Empirical evidence from China A-shares

This study explores the relationship between stocks' change in salience (CS) and the cross-section of stock returns. We find that the change in salience can negatively predict future stock returns. Investors, attracted by salient attributes of choices, overestimate prominent rising trends in stock historical return performance and extrapolate, leading stocks with prominent rising trends to be overpriced and earning lower subsequent returns. In terms of potential mechanisms, we find that costly arbitrage and lottery preference are two underlying mechanisms behind the mispricing of CS. The CS effect is more pronounced among stocks with greater costly arbitrage and greater lottery preference. Moreover, both institutional and individual investors are shown to generate distortions of expectations induced by salient thinking. Our findings are robust after considering common risk factors, shell contamination, short-term reversals, the prospect theory, and investor attention.

Forecasting stock market returns with a lottery index: Evidence from China

AbstractThis study constructs a Chinese lottery index (LI) based on six popular lottery preference variables by using the partial least squares method and examines the relationship between the LI and future stock market returns during the period from January 2000 to December 2021. We find that the LI can negatively predict stock market excess returns in‐sample and out‐of‐sample. In addition, the LI can generate a large economic gain for a mean–variance investor. Finally, the predictive sources of the LI stem from a cash flow channel and can be explained by the positive volume–volatility relationship and investor attention.

Leverage Is a Double‐Edged Sword

ABSTRACTWe use proprietary data on intraday transactions at a futures brokerage to analyze how implied leverage influences trading performance. Across all investors, leverage is negatively related to performance, due partly to increased trading costs and partly to forced liquidations resulting from margin calls. Defining skill out‐of‐sample, we find that relative performance differentials across unskilled and skilled investors persist. Unskilled investors' leverage amplifies losses from lottery preferences and the disposition effect. Leverage stimulates liquidity provision by skilled investors, and enhances returns. Although regulatory increases in required margins decrease skilled investors' returns, they enhance overall returns, and attenuate return volatility.

Lottery Preference for Factor Investing in China’s A-Share Market

Lottery Preference for Factor Investing in China’s A-Share Market

Do the rich gamble in the stock market? Low risk anomalies and wealthy households

Contrary to the theoretical principle that higher risk is compensated with higher expected return, the literature shows that low-risk stocks outperform high-risk stocks. Using a large-scale household dataset, we provide an explanation for this puzzling result that the anomalous negative risk-return relation is only confined to those stocks predominantly held by rich households, whereas the anomaly disappears for stocks held by non-rich households and institutional investors. We find that social status concern of rich households and the induced lottery preference explain wealthy investors’ demand for high-risk stocks, leading to overpricing and low future returns for such stocks.

Lottery demand, lottery factor, and anomalies

AbstractWe provide an overview of the literature investigating (retail) investors' demand for lottery‐like stocks. We summarize different sets of lottery proxies and discuss their implications for cross‐sectional pricing of individual stocks. We present empirical evidence and summarize the findings including (i) the robustness of the lottery demand effect using an extended data set, (ii) the economic underpinnings of the lottery demand effect, and (iii) the explanatory power of the lottery preference factor for established stock market anomalies.

Market States and Lottery Preference: Evidence from Chinese Open‐End Funds*

AbstractRecent studies find that investors prefer funds with lottery‐like payoffs. Using a sample of Chinese open‐end funds, we show that investors' preference for funds' extreme positive payoffs (MAXs) depend on the state of the market: it is significant for MAXs in an unfavorable market but weak or reversed for those in a favorable market. Such state‐dependent preference is irrational because, inconsistent with the flow–MAX relationship, higher MAXs under market downturns are associated with worse performance. We further document support for the salience‐theory‐based explanation for investors' preference and provide counter‐evidence for alternative mechanisms based on rational choice or changes in aggregate flows.

Lottery preference, short-sale constraint, and the salience effect: Evidence from China

This paper documents the significant and robust salience theory (ST) effect in China, which differs from the findings in the literature. First, the upside-ST effect from stocks with salient upsides is stronger than the downside-ST effect from stocks with salient downsides; the opposite pattern is documented in the US market. We demonstrate that this pattern is due to strong lottery preference and short-sale constraint in China, where investors are prone to engage in salient thinking when they bet on lottery stocks; meanwhile, short-sale constraint prevents rational investors from correcting salience-induced mispricing. Second, the salience effect remains strong in big stocks and high institutional ownership stocks. Our findings are consistent with the existing evidence that fund managers cater to fund investors' lottery preferences to hold lottery stocks. Our study provides new insights into the sources of the salience effect in China, especially salience's interaction with investor behaviors and the market's institutional characteristics.

CEO overconfidence, lottery preference and the cross-section of stock returns

Unlike existing studies that mostly focus on investors’ biased behavior in explaining the lottery-related anomaly, our study highlights the importance of CEO overconfidence for the anomaly. We propose that CEO overconfidence could enhance investors’ confidence in the stock's price even if the stock exhibits lottery-like payoffs. As a result, lottery stocks with overconfident CEOs are less prone to subsequent underperformance. Based on portfolio-based analyses and cross-sectional regressions, we provide robust evidence to confirm this hypothesis. Our study has important implications to the literature on both lottery-related anomaly and CEO overconfidence.

Blinded by Lottery Preferences? Earnings News, Gambling-Motivated Trading, and Informational Efficiency

Blinded by Lottery Preferences? Earnings News, Gambling-Motivated Trading, and Informational Efficiency

Idiosyncratic volatility, turnover and the cross-section of stock returns: evidence from the Korean stock market

PurposeThe authors aim to understand the driving forces behind the idiosyncratic volatility puzzle in the Korean stock market. The authors study the Korean stock market because previous works report a strong idiosyncratic volatility puzzle in Korea, and the market for the exchange-traded funds (ETFs) including low volatility ETFs has experienced drastic growth in Korea.Design/methodology/approachUsing common stocks listed either on KOSPI or KOSDAQ over the period 1997–2016, the authors estimate idiosyncratic volatility using the Fama–French three-factor model. In addition, based on prior literature, the authors use turnover as a proxy for overvaluation. The authors then study the role of turnover in understanding the idiosyncratic volatility puzzle in Korea.FindingsThe authors find that turnover is highly associated with idiosyncratic volatility. Turnover is extremely large among firms with high idiosyncratic volatility and the puzzle disappears after we control for turnover, meaning that turnover subsumes the explanatory power of idiosyncratic volatility for equity returns. The authors also find underperformance of stocks with high turnover and high idiosyncratic volatility exclusively during earnings announcement periods. Overall, our finding implies that the puzzle arises since high idiosyncratic volatility stocks due to high turnover are overvalued and experience correction afterwards.Originality/valueLiterature has suggested explanations based on lottery preferences of investors and market frictions behind the idiosyncratic volatility puzzle. What makes our study distinct from previous work is that we find the role of turnover in understanding the idiosyncratic volatility puzzle using turnover measure as a proxy for overvaluation in the Korean stock market.

Lottery demand and the asset growth anomaly

The negative relation between asset growth (AG) and future stock returns is particularly featured by the overvaluation of high AG stocks. We propose that such overvaluation is attributed to investors’ lottery demand toward stocks with high maximum daily returns (MAX), resulting in higher AG premium among high MAX stocks. Our empirical results confirm this prediction. Further evidence indicates that the impact of lottery preference on the AG anomaly is robust to several alternative explanations, including overinvestment, limits-to-arbitrage, and the q-theory. Our study provides a new insight into the understanding of the AG anomaly.

Simplicity and Probability Weighting in Choice under Risk

We present a speculative application of model estimates from Fudenberg and Puri (2021) to prize-linked savings in South Africa. The models used include one combining simplicity theory (Puri 2018, 2022), a preference for lotteries with fewer possible outcomes, with cumulative prospect theory. The results and those of prior literature indicate that both simplicity and probability weighting have a role to play in understanding behavior in choice under risk. We discuss the properties of these models and their implications for behavior.

Time-dependent lottery preference and the cross-section of stock returns

Highlighting the importance of benchmark to identify lottery-like payoffs of stocks, this study proposes that investors’ lottery preference is formed toward tracking stocks’ performance over time. Accordingly, we develop a strategy based on time-dependent maximum daily return (denoted as TMAX) by buying (short selling) stocks with the most recent maximum daily returns (MAX) ranked in the bottom (top) decile of the historical distribution. The TMAX strategy generates significant premium that subsumes the profitability of Bali, Cakici, and Whitelaw’s (2011) MAX strategy, but not vice versa. A major advantage of the TMAX strategy is its time-invariant profitability across different periods and sentiment states. Further analyses show that the TMAX premium can be explained by shorting flow and behavioral theories, supporting the time-dependent feature of lottery preference. • We propose that investors’ lottery preference is formed toward tracking stocks’ performance over time. • We develop the TMAX strategy based on time-dependent maximum daily return. • The TMAX strategy generates significant premium that subsumes the profitability of the MAX strategy, but not vice versa. • The TMAX strategy has time-invariant profitability across different periods and sentiment states. • The TMAX premium can be explained by shorting flow and behavioral theories.

The reference dependency of short-term reversal

The short-term reversal anomaly has been believed to be compensation for liquidity provision. We put forth the hypotheses that i) liquidity provision for a stock increases with the stock's capital gains overhang and ii) short-term reversal is more pronounced for the stocks with a large capital loss overhang. Our empirical findings support our hypotheses and the results hold firmly, even after we control for risk as well as lottery preferences and past return effects. We also document that this reference dependency of short-term reversal is stronger among stocks with low institutional ownership and during the low liquidity period.

Lottery preferences and retail short selling

Unlike developed countries, the prominent participants in the Taiwanese stock market are individual investors. This study found that retail short-sellers in Taiwan can predict stock prices and perform better with stocks held primarily by retail investors with a preference for lottery-like payoffs. Moreover, short-sellers make lower profits with stocks with lottery features in the absence of the uptick rule. The findings are robust when considering the effect of institutional short selling, alternative lottery-like measures such as retail trading activity, arbitrage risk, and distinct macroeconomic conditions. Overall, the results suggest that retail investors are not necessarily noise traders. Based on divergence-of-opinion theory (Miller, 1977), heterogeneous retail investors make trades due to their differences in sentiments. Meanwhile, retail short-sellers include professionals in profitmaking through short-selling by gauging the gambling propensity of general retail investors. Consequently, removing short-selling restrictions can increase the spillover effect of short-sellers' trading signals and help other retail investors move and adjust their investments in lottery-like stocks.

Lottery preference and stock market participation: evidence from China

PurposeThis paper studies the effects of lottery preference on stock market participation at the macro level.Design/methodology/approachThe authors use the abnormal search volume intensity for lottery-related keywords from the Baidu search engine to capture retail investors' lottery preference. To measure stock market participation, they use five different macro-level measures from various angles. They perform the time series regression analysis in their empirical study.FindingsFirst, the validation tests show that the lottery preference index in this study is reasonable. Further, the authors find that lottery preference increases people's propensity to enter and trade in the stock market. Besides, they find that the effect on trading behavior is asymmetric, that is, high lottery preference has a more significant impact on trading behavior than low lottery preference. However, lottery preference has no significant effect on the stockholding.Originality/valueThis paper contributes to the growing literature that examines the determinants of stock market participation and the role of lottery/gambling preference in the financial market. It also provides direct and novel evidence for Statman's (2002) conclusions about the similarity of lottery players and stock traders.