Investing in lottery-like stocks in India

Abstract

Purpose

In the current study, the significance of extreme positive returns has been investigated in the pricing of stocks in the Indian equity market. This study aims to understand if investors in India have a preference for lottery-like stocks. The existing literature provides support for MAX effect in several countries, where risk seeking in the form of gambling is an acceptable form of social behavior, suggesting a preference for lottery-like stocks. This motivates the authors to investigate whether such preference for lottery-like stocks is prevalent in a country such as India with a different cultural setting, where gambling is not socially and legally encouraged.

Design/methodology/approach

The MAX effect is tested in the Indian market for the period from January 2003 to March 2017. The average number of firms per month in this study is 2,949. Univariate and bivariate portfolio-level analyses, as well as Fama MacBeth regressions, are conducted to observe the difference between average raw and risk-adjusted returns between the stocks lying in the highest and lowest MAX deciles. Several tests have been performed for checking the robustness of the findings.

Findings

Unlike the extant literature, the authors have not found any evidence of a negative relationship between extreme positive returns and expected returns. The univariate and bivariate analyses suggest that high MAX deciles over-perform low MAX deciles. Fama Macbeth regressions also do not support the negative relationship documented for other markets. This suggests that investors are not euphoric about lottery-like stocks in India. One may devise profitable trading strategies by going long on high MAX deciles and short on low MAX deciles.

Originality/value

This study finds a behavioral aspect of Indian investors, which seems to be in contrast to that of other countries. While there is a strong preference for lottery-like stocks in other markets, investors in India do not end up overpaying for such stocks in the market. This tendency might be an outcome of a different social and regulatory setting in India. In view of the fact that India is increasingly becoming an important investment destination, it becomes important to devise investment strategies based on the peculiarities of this market rather than simply extrapolating the findings of other markets.

Citation

Sharma, U. and Chakraborty, M. (2021), "Investing in lottery-like stocks in India", Studies in Economics and Finance, Vol. 38 No. 3, pp. 640-658. https://doi.org/10.1108/SEF-04-2018-0099