Hot Potatoes: Underpricing of Stocks following Extreme Negative Returns
45 Pages Posted: 19 Jan 2021 Last revised: 1 Apr 2021
Date Written: March 26, 2021
Abstract
Although it is well established that investors are willing to accept a negative premium for lottery-like stocks, it is puzzling that the opposite effect is not observed in stocks experiencing large daily losses. We find that stocks that experience large negative daily returns (MIN) also display large positive daily returns (MAX); therefore the MIN effect is subdued. Once stocks ranked as high-MAX within MIN deciles are removed, we find that MIN positively predicts future stock returns. More importantly, a strategy that buys pure high-MIN stocks and shorts pure high-MAX stocks generates superior returns compared to stand-alone MAX and/or MIN strategies.
Keywords: extreme returns, maximum daily losses, underpricing
JEL Classification: G11, G12, G17
Suggested Citation: Suggested Citation
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