Extreme returns, lottery mindset, and the idiosyncratic volatility puzzle
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Volume Title
School of Business |
Bachelor's thesis
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Author
Date
2020
Department
Major/Subject
Mcode
Degree programme
Rahoitus
Language
en
Pages
27 + 4
Series
Abstract
This thesis revisits the evidence recently found on the negative influence of extreme positive daily returns in prior months in the cross-sectional pricing of stocks, also known as the MAX effect. I examine the existence and nature of the MAX effect in the euro area over 1990-2019 with portfolio-level analysis and firm-level cross-sectional regressions. I find strong evidence regarding the increasing magnitude in the overvaluation of stocks the higher the maximum return in prior month develops. The phenomenon of investors preferring lotterylike stocks, typically exhibiting the MAX effect, results in over-demand, high volatility, and lower expected returns. Moreover, my research implies that both stock- and firm-wise peculiarities of lottery-like stocks have a tendency to sustain longitudinally. In my latter analysis, I focus on the idiosyncratic volatility and extreme returns, where my results suggest the puzzling negative relation between idiosyncratic volatility and returns, also known as the idiosyncratic volatility puzzle, becomes inverse after controlling for MAX.Description
Thesis advisor
Spickers, TheresaKeywords
MAX effect, expected returns, extreme positive returns, lottery-like stocks, idiosyncratic volatility puzzle
