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Asset pricing when trading is for entertainment

Jiang Luo and Avanidhar Subrahmanyam

Review of Behavioral Finance, 2019, vol. 11, issue 2, 220-264

Abstract: Purpose - High levels of turnover in financial markets are consistent with the notion that trading, like gambling, yields direct utility to some agents. The purpose of this paper is to show that the presence of these agents attenuates covariance risk pricing and volatility, and implies a negative relation between volume and future returns. Since psychological literature indicates that the desirability of a gamble arises from the Design/methodology/approach - Analytical. Findings - The presence of gamblers attenuates covariance risk pricing and volatility, and implies a negative relation between volume and future returns. If gamblers prefer more volatile stocks, these stocks earn lower average returns in equilibrium. If agents’ utility from trading increases when they make positive profits in earlier rounds (e.g. to an endowment effect), this leads to higher volume and lower volatility in up markets relative to down markets. Originality/value - No paper has previously modeled agents who derive direct utility from trading.

Keywords: Finance; Volume; Behavioural (search for similar items in EconPapers)
Date: 2019
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