The Lottery Mindset: Investors, Gambling and the Stock Market (eBook)

Wai-Mun Fong is Associate Professor at the NUS Business School, National University of Singapore, where he teaches Personal and Corporate Finance and Wealth Management to PhD, MSc and Undergraduate level students. He obtained his PhD in Financial Economics from the University of Manchester in 1992, and has since contributed to and authored various financial books and journals. His main areas of research include empirical asset pricing, investment strategies, personal finance and behavioural finance.

Cover 1
Half-Title 2
Title 4
Copyrights 5
Contents 6
List of Figures 9
List of Tables 11
Preface 13
About the Author 15
1 A Survey of Behavioral Finance 16
1.1 The behavioral finance paradigm 17
1.2 Investor preferences 20
1.2.1 Mental accounting 20
1.2.2 Preference for concentrated portfolios 21
1.2.3 Preference for the familiar 22
1.2.4 Preference for lottery-type stocks 23
1.2.5 Preference for active trading 24
1.3 Heuristics 25
1.3.1 The availability heuristic 25
1.3.2 The anchoring heuristic 26
1.3.3 The representativeness heuristic 27
Categorical predictions 27
The “law of small numbers” 29
1.4 Beliefs 30
1.5 Emotions 33
1.5.1 Gains and losses: Prospect Theory 33
1.5.2 Rejoicing and regret 36
1.5.3 Optimism 36
1.5.4 The social psychology of emotions 38
1.6 Conclusion 39
2 Overtrading 40
2.1 Introduction 41
2.2 Turnover on equity markets 41
2.3 The profitability of individual investor trades 43
2.3.1 US studies 43
2.3.2 Non-US studies 47
2.4 Learning from trading 49
2.5 Do smart investors outsmart the market? 51
2.6 Why do individual investors trade so much? 52
2.6.1 Risk preferences 53
2.6.2 Sensation-seeking 54
2.6.3 Stocks as lotteries 55
2.6.4 Beliefs and sentiment 57
2.6.5 Heuristics 59
2.7 Conclusion 60
3 Trend-Chasing 61
3.1 Introduction 62
3.2 The “hot-hand” fallacy and the gambler’s fallacy 63
3.3 Trend-chasing in stock markets 66
3.3.1 Experimental evidence 66
3.3.2 Survey evidence 67
3.4 Trend-chasing: mutual fund investors 69
3.5 Behavioral biases of mutual fund investors 75
3.6 Trend-chasing behavior in the aggregate stock market 81
3.7 Conclusion 87
Appendix: Dollar-weighted returns and institutional ownership 87
4 Growth Stocks 92
4.1 Introduction 93
4.2 The value premium revisited 93
4.2.1 The US value premium 94
4.2.2 The international value premium 96
4.3 Lottery stock preference, arbitrage risk, and the value premium 100
4.4 The Persistence of lottery-stock preferences 102
4.5 Earnings extrapolation and the value premium 107
4.6 Conclusion 109
Appendix 4.1: Lottery factors 110
Appendix 4.2: Earnings growth persistence: is it there? 112
5 The Beta Anomaly 116
5.1 Introduction 117
5.2 The beta anomaly around the world 118
5.2.1 US evidence 118
5.2.2 International evidence 120
5.3 The beta anomaly: long-run consequences 123
5.4 Omitted risks 125
5.4.1 Financial distress 125
5.4.2 Liquidity risk 128
5.5 Explaining the beta anomaly 129
5.6 Conclusion 132
Appendix 5.1: Distress and liquidity measures 133
Appendix 5.2: Institutional ownership and the beta anomaly 135
6 The IVOL Puzzle 137
6.1 Introduction 138
6.2 The IVOL anomaly revisited 138
6.3 Who invest in high-IVOL stocks? 143
6.4 Does idiosyncratic skewness drive the IVOL effect? 146
6.5 IVOL and beta 148
6.6 Conclusion 152
7 The MAX Effect 153
7.1 Introduction 154
7.2 Sizing up the MAX anomaly 155
7.3 Investor sentiment and the MAX effect 158
7.4 Institutional ownership and the MAX effect 163
7.5 Sentiment or fundamentals? 165
7.6 Explaining the MAX effect: salience and lottery stock preference 168
7.7 Conclusion 170
8 Conclusion 171
Bibliography 174
Index 193