Swedroe: Investors Prefer ‘Gambling’ Stocks

December 12, 2016

  • Large numbers of stocks, 14.3% of all stocks (12.0% by market capitalization) in the Center for Research in Security Prices universe, are significantly affected by gambling sentiment. This is an economically significant percentage of stocks that co-move significantly with a portfolio of high-LIDX stocks.
  • Return co-movement among lotterylike stocks is strongest for lottery stocks located in regions where investors have stronger preferences for gambling, as proxied by the CPRATIO.
  • Lotterylike stocks co-move strongly with one another, providing evidence that this return co-movement is generated by the correlated trading of gambling-motivated investors.
  • High-LIDX stocks not only co-move significantly with one another, but are also less sensitive to other standard investment factors (beta, size, value and momentum).
  • Retail as well as institutional investors in high-CPRATIO areas allocate larger portfolio weights to local as well as nonlocal high-LIDX stocks, and trade them more actively.
  • Retail investor trades are more correlated, and comprise a larger fraction of trading volume, when CPRATIO and LIDX are high. Institutional investors exhibit a similar, but weaker, pattern.
  • The relation between CPRATIO and lottery-stock co-movement is strongest when gambling enthusiasm, as proxied by state lottery sales, is high.
  • The relation between CPRATIO and lottery-stock co-movement is stronger when the local economy performs well, which allows gambling-motivated investors to increase their demand for lotterylike stocks.
  • Excess return co-movement is higher for stocks that are held more often by investors from higher-CPRATIO areas; younger investors; lower-income, nonprofessional, unmarried and male investors; and investors with lower education levels and more concentrated portfolios. These groups tend to exhibit a stronger preference for gambling (which negatively impacts returns).


Kumar, Page and Spalt noted that their findings were robust to explicit controls for local income, education and other geographic characteristics (such as local economic conditions) as well as to a variety of firm-level controls and year- and industry-fixed effects, and they weren’t exclusive to financial centers or any particular region in the United States.

They concluded: “We find robust evidence that lottery-like stocks that are disproportionately held by gambling-motivated investors co-move more strongly with other lottery stocks. This suggests that the excess return co-movement we observe among lottery-like stocks is driven by the trading behavior of investors with gambling preferences.”

Their findings have important implications for investors’ portfolio decisions. First, investors who are not aware of their biases, the riskiness of these “gambling stocks” and their poor returns are likely to overweight these stocks in their portfolios.

You no longer have that excuse. Unless you place value on the entertainment aspect of gambling when investing, you should avoid stocks with gambling characteristics, as they have very poor risk-adjusted returns.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.


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