Volume 29, Issue 5, 2020
DOI: 10.24205/03276716.2020.1036
Extreme Daily Returns, Lottery Mindset, Idiosyncratic Volatility and the Cross-Section of Stock Returns in a Comparatively Small Emerging Market
Abstract
The existing literature on developed and advanced emerging markets documents that the expected stock returns exhibit a positive-, negative-, and no-relationship with both idiosyncratic volatility (IVOL) and extreme daily returns (MAX or MIN). Different from developed and advanced emerging markets, the Pakistani market (PSX) is at its initial development stage with a comparatively little investment knowledge and scarcity of funds that may hinder to achieve a well-diversified portfolio. Such investment conditions may lead investors to suffer from under-diversification and behavioral biases, and therefore, provide an ideal situation to examine the IVOL, MAX and MIN effects and the relationship among these variables in the Pakistani stock market. We find a robust negative MAX effect, which is not subsumed by IVOL, MIN, and other control variables. Whereas, IVOL and MIN effects are weak and unreliable. The negative MAX-return relationship and positive MIN-return relationship indicate both preference for stocks with lottery-type features and risk-seeking behavior among the Pakistani investors. The results are robust to controls for various firm specific characteristics
Keywords
extreme daily returns; idiosyncratic volatility; MAX and MIN effects; gambling behavior; lottery stocks in emerging markets