Maxing Out: Stocks as Lotteries and the Cross-Section of Expected Returns
Turan G. Bali
Georgetown University - Robert Emmett McDonough School of Business
New York University; National Bureau of Economic Research (NBER)
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).
Number of Pages in PDF File: 49
Keywords: expected stock returns, maximum returns, idiosyncratic volatility, skewness
JEL Classification: G10, G11, C13
Date posted: September 3, 2008 ; Last revised: February 27, 2012
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