Hot Potatoes: Underpricing of Stocks following Extreme Negative Returns

Abstract

Although investors 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 many 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 the MIN effect produces significantly higher next-month returns. The subsequent-month returns following MIN are particularly higher when stocks experience negative cumulative monthly returns, when firm-specific investor sentiment is low, and when stocks are near their 52-week lows.

Keywords: extreme returns, large daily losses, underpricing

JEL Classification: G11, G12, G17