Attractiveness to Optimists and Stocks as Lotteries in the Cross-section of Expected Stock Returns
58 Pages Posted: 11 Dec 2020 Last revised: 12 May 2022
Date Written: May 12, 2022
Theoretical studies find that optimistic investors, who overweight the probabilities of better outcomes, can survive and influence asset prices even in a competitive market. To study the impact of optimistic investors on the cross-section of expected stock returns, I define the measure of attractiveness to optimists of a stock based on rank-dependent probability weighting. In both portfolio-level and firm-level analyses, I find an economically and statistically significant negative relation between the measure of attractiveness to optimists and the expected stock return even after controlling for a set of control variables in the cross-section of U.S. stock returns. Furthermore, this framework both conceptually and empirically subsumes the MAX effect, one of the most common characteristics for lottery-type stocks.
Keywords: Optimistic investor, stocks as lotteries, stock returns, rank-dependent probability weighting
JEL Classification: G11, G12
Suggested Citation: Suggested Citation