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Skewness, Individual investor preference, and the Cross-Section of Stock Returns

Last Updated on 10 February, 2024 by Rejaul Karim

The paper “Skewness, Individual investor preference, and the Cross-Section of Stock Returns” by Tse-Chun Lin and Xin Liu finds a robust negative relation between skewness/lottery-like features, proxied by maximum return (MAX) over the last month, and future returns for stocks preferred by individual investors.

The authors identify stocks preferred by individual investors through bundling 10 stock characteristics associated with their stock preferences. The negative relation between MAX and future return is produced by the stocks preferred by individuals that account for less than 5% of the overall market capitalization.

The paper’s results are robust to alternative definitions of MAX and lottery-like features such as total, idiosyncratic, and expected skewness.

Abstract Of Paper

We find a robust negative relation between skewness/lotter-like features, proxied by maximum return (MAX) over the last month, and future returns for stocks preferred by individual investors. This negative relation is nonexistent for the rest of stocks. We identify stocks preferred by individual investors through bundling 10 stock characteristics associated with their stock preferences. The negative relation between MAX and future return is produced by the stocks preferred by individuals that account for less than 5% of the overall market capitalization. Our results are robust to alternative definitions of MAX and lotter-like features such as total, idiosyncratic, and expected skewness.

Original paper – Download PDF

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Author

Tse-Chun Lin
The University of Hong Kong – Faculty of Business and Economics

Xin Liu
School of Finance, Renmin University of China

Conclusion

The paper “Skewness, Individual investor preference, and the Cross-Section of Stock Returns” by Tse-Chun Lin and Xin Liu concludes that there is a robust negative relation between skewness/lottery-like features, proxied by maximum return (MAX) over the last month, and future returns for stocks preferred by individual investors.

The authors identify stocks preferred by individual investors through bundling 10 stock characteristics associated with their stock preferences. The negative relation between MAX and future return is produced by the stocks preferred by individuals that account for less than 5% of the overall market capitalization.

The paper’s results are robust to alternative definitions of MAX and lottery-like features such as total, idiosyncratic, and expected skewness.

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FAQ

What is the main finding of the paper “Skewness, Individual investor preference, and the Cross-Section of Stock Returns”?

The main finding of the paper is a robust negative relationship between skewness/lottery-like features, specifically proxied by maximum return (MAX) over the last month, and future returns for stocks that are preferred by individual investors. This negative relation is observed in the context of stocks preferred by individual investors, but it is nonexistent for the rest of the stocks.

How do the authors identify stocks preferred by individual investors?

The authors identify stocks preferred by individual investors by bundling 10 stock characteristics associated with individual investor preferences. These characteristics are used to categorize and distinguish stocks that are more likely to be preferred by individual investors.

What is the significance of the negative relation between MAX and future returns?

The negative relation between MAX (maximum return over the last month) and future returns is particularly pronounced for stocks preferred by individual investors, constituting less than 5% of the overall market capitalization. This suggests that the observed negative relationship is driven by a specific subset of stocks in the market.

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