Why 'lottery stocks' don't pay

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Advisers who have clients wanting to take a chance on the 'lottery stocks' should maybe steer them away, as new research reveals they don’t pay.
Research from the Capital Markets Cooperative Research Centre (CMCRC) has found investors who invest in so-called ‘lottery stocks’ end up worse off.

The study, by CMCRC PhD candidate Grace Lepone from the Macquarie Graduate School of Management and Danika Wright from the University of Sydney, examined lottery stocks – which have a small probability of a high reward, but a negative expected payoff.
Using brokerage data for Australian retail investors from 1 February 2010 to 28 February 2013, they found such assets significantly underperformed on a risk-adjusted basis.
Risk-seeking investors tended to overweight their portfolios to these lottery stocks, and suffered from inferior investment returns.
“Using a large sample of Australian retail investors portfolio and trading data, we were able to identify investors who were more risk seeking than others,” said Lepone.
“Contradictory to the assumption of classical financial theory, some investors do exhibit a risk-seeking preference and these investors tend to underperform.”
The study also looked at whether investors are more risk-averse – or risk-seeking – following gains in their portfolios.
“Again, contrary to classical beliefs we discovered that not only risk-seeking investors, but also risk-averse investors, are more likely to make a risk-seeking decision following a portfolio gain,” she said.
“These findings have significant implications for behavioural finance research and our understanding of market efficiency.”
While these results were based on retail investors they have implications for institutional investor behavior as well.
“Investment decisions at institutions are made by people too, and it’s probably that these behaviours apply at that level as well,” said Gong.
“Being more cognisant of likely behaviours relating to risk could have applications for better managing investment decisions that directly affect superannuation and pension returns for huge numbers of people.”
CMCRC is funded equally by the Australian Government, an alliance of University partners and industry partners including regulators, exchanges and market participants across 10 countries.