Maxing Out: Stocks as Lotteries and the Cross-Section of Expected Returns
49 Pages Posted: 3 Sep 2008 Last revised: 27 Feb 2012
Date Written: February 2010
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).
Keywords: expected stock returns, maximum returns, idiosyncratic volatility, skewness
JEL Classification: G10, G11, C13
Suggested Citation: Suggested Citation