Asset Pricing When Trading Is for Entertainment

Review of Behavioral Finance, Forthcoming

67 Pages Posted: 23 May 2016 Last revised: 30 Apr 2018

See all articles by Jiang Luo

Jiang Luo

Nanyang Technological University (NTU) - Division of Banking & Finance

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area; Institute of Global Finance, UNSW Business School; Financial Research Network (FIRN)

Date Written: June 12, 2017

Abstract

High levels of turnover in financial markets are consistent with the notion that trading, like gambling, yields direct utility to some agents. We show that the presence of these agents attenuates covariance risk pricing and volatility, and implies a negative relation between volume and future returns. Since psychological literature indicates that the desirability of a gamble arises from the ex ante volatility of the outcome, we propose that agents derive greater utility from trading more volatile stocks. These stocks earn lower average returns in equilibrium, although the risk premium on the market portfolio is positive. We then consider a dynamic setting where agents’ utility from trading increases when they make positive profits in earlier rounds (due, for example, to an endowment effect). This leads to “bubbles,” i.e., disproportionate jumps in asset returns as a function of past prices, higher volume in up markets relative to down markets, as well as a leverage effect, wherein down markets are followed by higher volatility than up markets.

Keywords: Trading, Volume, Gambling, Covariance Risk

JEL Classification: G00, G12, G14

Suggested Citation

Luo, Jiang and Subrahmanyam, Avanidhar, Asset Pricing When Trading Is for Entertainment (June 12, 2017). Review of Behavioral Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2782817 or http://dx.doi.org/10.2139/ssrn.2782817

Jiang Luo

Nanyang Technological University (NTU) - Division of Banking & Finance ( email )

S3-01C-75 50 Nanyang Avenue
Singapore, 639798
Singapore

Avanidhar Subrahmanyam (Contact Author)

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-5355 (Phone)
310-206-5455 (Fax)

Institute of Global Finance, UNSW Business School

Sydney, NSW 2052
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
174
Abstract Views
1,448
rank
180,744
PlumX Metrics