Among some of the most well-documented stock market anomalies are four apparently unrelated factors: proﬁtability (firms with high expected proﬁtability exhibit higher future returns), distress risk (limited liability produces skewness in returns), lotteryness (individual investors who exhibit lottery demand are willing to accept lower returns in exchange for a small chance to receive a big payoff) and idiosyncratic volatility.
Turan Bali, Luca Del Viva, Neophytos Lambertides and Lenos Trigeorgis contribute to the literature on these anomalies through their May 2017 study, “Seemingly Unrelated Stock Market Anomalies: Proﬁtability, Distress, Lotteryness and Volatility.”
The authors explain: “Growth, distress, and lotteryness involve real options that might increase the idiosyncratic skewness of the distribution of the ﬁrm’s equity returns. If investors prefer stocks with embedded real options and have preferences for more positive idiosyncratic skewness, then high idiosyncratic skewness oﬀered by ﬁrms with such real options might entice investors to accept lower expected returns.”
Thus, they considered a measure of growth options and related measures of proﬁtability—controlling for asset growth in interaction with volatility—as well as distress and lotteryness, as potential drivers of idiosyncratic skewness, and examined whether their impact is priced in the cross section of equity returns.
The authors explain: “High-growth (and likely low current proﬁtability) ﬁrms, which tend to belong in high skewness subsets, would beneﬁt more from high convexity (being out-of-the-money options on the ﬁrm’s assets) in more volatile environments as they have more optionality to beneﬁt and less (ﬁxed scale) commitment to lose from demand variability.”
Their study covered 12,709 U.S. listed ﬁrms during the period 1983 to 2015. Following is a summary of their findings: