Who Gambles in the Stock Market?
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What they found
Kumar defined 'lottery stocks' as those with low price, high idiosyncratic volatility, and high idiosyncratic skewness (a small chance of a huge payoff), and asked who buys them. Using brokerage data and demographics, he found that the same groups that buy state lotteries (lower-income, less educated, young, urban, in areas with more lottery spending) overweight lottery stocks, and that lottery stocks as a group underperformed significantly. Preference for lottery-like payoffs cost these investors about 1% to 2% a year, more for those who concentrated in them.
What you can use
- Cheap, volatile, 'could 10x' stocks are lottery tickets, and like lottery tickets they have negative expected returns.
- The appeal of a big payoff is a bias that shows up in who buys these stocks and in how they perform.
- If a stock's main attraction is the size of the possible win, the research says the price already reflects that and then some.
Caveats
Definitions of 'lottery' are the author's construction; the underperformance is concentrated in the most extreme stocks. Brokerage data from 1991 to 1996.
Tags: retail, lottery-stocks, skewness, behavioral
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.