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Do investors overpay for stocks with lottery-like payoffs? An examination of the returns of OTC stocks

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  • Eraker, Bjørn
  • Ready, Mark

Abstract

We study returns on over-the-counter stocks and find that these returns are extremely negative on average. The distribution of OTC stock returns is highly positively skewed: while many of the stocks in our sample become worthless, a few do extremely well. We investigate whether this negative return premium can be rationalized by investors׳ preference for positively skewed payoffs. We show that the equilibrium model of Barberis and Huang (2008) provides a plausible explanation for the negative returns. We also show that OTC stocks that once traded on the regular exchanges perform much better than stocks that originate in the OTC markets.

Suggested Citation

  • Eraker, Bjørn & Ready, Mark, 2015. "Do investors overpay for stocks with lottery-like payoffs? An examination of the returns of OTC stocks," Journal of Financial Economics, Elsevier, vol. 115(3), pages 486-504.
    • Handle: RePEc:eee:jfinec:v:115:y:2015:i:3:p:486-504
    DOI: 10.1016/j.jfineco.2014.11.002
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    More about this item

    Keywords

    Prospect theory; Skewness; Lottery stocks; OTCBB;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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