Friday, May 20, 2005

Who Gambles in the Stock Market? by Alok Kumar

Option theory meet portfolio selection. It fits the theory perfectly, even though I am less sure of some of the non economic aspects (for instance, why would Catholics be more likely to take chances), but it sure is an interesting paper that does fit with theory.

Short version: the poor take bigger chances. (gee, Option theory would predict that perfectly!)

SSRN-Who Gambles in the Stock Market? by Alok Kumar

If a desire to escape poverty induces gambling, socio-economic factors which promote lottery purchases are also likely to induce investors to adopt sub-optimal stock investment strategies. Specifically, investors with a large differential between their existing economic status and their aspiration levels would tilt their portfolios toward riskier lottery-type stocks. However, these investors may hold riskier stocks not necessarily because they are risk-seeking but rather because they want to have a positive probability, albeit very small, of reaching their aspiration levels."
A friend of mine calls lotteries taxes on the stupid (overlooking the physic pleasure of playing). Kumar addresses this point not by using intelligence, but rather education:
"investor characteristics may influence probability distortions, where relatively sophisticated investors are less likely to distort the small probabilities. For instance, educated individuals are more likely to understand the odds of winning while relatively less educated individuals may significantly distort the winning odds. If education is correlated with income and wealth, rich individuals are less likely to participate in lotteries."
One final quote:
"I assume that investors are more likely to perceive lower-priced stocks with very small but positive potential for high returns as lotteries. I further assume that stocks with higher variance (or higher idiosyncratic volatility or extreme returns) and positively skewed returns are likely to be perceived as high payoff potential stocks."

Kumar, Alok, "Who Gambles in the Stock Market?" (May 2005).

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