TY - JOUR
AU1 - Luo, Jiang
AU2 - Subrahmanyam, Avanidhar
AB - High levels of turnover in financial markets are consistent with the notion that trading, like gambling, yields direct utility to some agents. The purpose of this paper is to show that the presence of these agents attenuates covariance risk pricing and volatility, and implies a negative relation between volume and future returns. Since psychological literature indicates that the desirability of a gamble arises from the ex ante volatility of the outcome, the authors propose that agents derive greater utility from trading more volatile stocks. These stocks earn lower average returns in equilibrium, although the risk premium on the market portfolio is positive. The authors then consider a dynamic setting where agents’ utility from trading increases when they make positive profits in earlier rounds (e.g. due to an endowment effect). This leads to “bubbles,” i.e. disproportionate jumps in asset returns as a function of past prices, higher volume in up markets relative to down markets, as well as a leverage effect, wherein down markets are followed by higher volatility than up markets.Design/methodology/approachAnalytical.FindingsThe presence of gamblers attenuates covariance risk pricing and volatility, and implies a negative relation between volume and future returns. If gamblers prefer more volatile stocks, these stocks earn lower average returns in equilibrium. If agents’ utility from trading increases when they make positive profits in earlier rounds (e.g. to an endowment effect), this leads to higher volume and lower volatility in up markets relative to down markets.Originality/valueNo paper has previously modeled agents who derive direct utility from trading.
TI - Asset pricing when trading is for entertainment
JF - Review of Behavioral Finance
DO - 10.1108/rbf-04-2018-0042
DA - 2019-06-24
UR - https://www.deepdyve.com/lp/emerald-publishing/asset-pricing-when-trading-is-for-entertainment-j6RYyYRS0G
SP - 220
EP - 264
VL - 11
IS - 2
DP - DeepDyve
ER -