Are Extreme Returns Priced in the Stock Market? European Evidence

19 Pages Posted: 14 Feb 2013

See all articles by Jan Annaert

Jan Annaert

University of Antwerp Department of Accounting & Finance; University of Antwerp - Antwerp Management School

Marc J. K. de Ceuster

University of Antwerp - Faculty of Applied Economics - City Campus

Kurt Verstegen

University of Antwerp - Faculty of Applied Economics

Date Written: February 1, 2013

Abstract

This paper revisits some recently found evidence in the literature on the cross-section of stock returns for a carefully constructed dataset of euro area stocks. First, we confirm recent results for U.S. data and find evidence of a negative cross-sectional relation between extreme positive returns and average returns after controlling for characteristics such as momentum, book-to-market, size, liquidity and short term return reversal. We argue that this is the case because these stocks have lottery-like characteristics, which is attractive to certain investors. Also, these stocks tend to be very volatile so that arbitrageurs are discouraged from correcting potential mispricing. As a consequence, these stocks are often overpriced which is observed through lower expected returns. Second, when we control for extreme returns, the recently found negative relationship between idiosyncratic risk and future returns seems to be less robust. In our models, after adding maximum returns, the relationship is insignificant and sometimes even positive. We also find that skewness is on its own negatively related to returns in our sample, as several asset pricing models predict.

Keywords: extreme returns, cross-section of expected returns, lottery-like payoffs, skewness, idiosyncratic volatility puzzle

JEL Classification: G12, G17, G15

Suggested Citation

Annaert, Jan and de Ceuster, Marc J. K. and Verstegen, Kurt, Are Extreme Returns Priced in the Stock Market? European Evidence (February 1, 2013). Available at SSRN: https://ssrn.com/abstract=2216561 or http://dx.doi.org/10.2139/ssrn.2216561

Jan Annaert (Contact Author)

University of Antwerp Department of Accounting & Finance ( email )

Faculty of Applied Economics
Prinsstraat 13
Antwerp, B-2000
Belgium

HOME PAGE: http://https://www.uantwerp.be/en/staff/jan-annaert/

University of Antwerp - Antwerp Management School ( email )

Boogkeers 5
Antwerp, 2000
Belgium

Marc J. K. De Ceuster

University of Antwerp - Faculty of Applied Economics - City Campus ( email )

Office B-337
Prinsstraat 13
Antwerp, Antwerp 2000
Belgium
+ 32 3 220 41 24 (Phone)
+ 32 3 220 40 64 (Fax)

HOME PAGE: http://www.ua.ac.be/marc.deceuster

Kurt Verstegen

University of Antwerp - Faculty of Applied Economics ( email )

Prinsstraat 13
Antwerp, 2000
Belgium
+32 (0) 3 265 41 20 (Phone)

HOME PAGE: http://www.ua.ac.be/kurt.verstegen

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