Footnote:
Nach Informationen von SSRN wurde die ursprüngliche Fassung des Dokuments March 17, 2023 erstellt
Description:
We study the return predictability by idiosyncratic skewness and find that it is limited to stocks trading at a capital loss overhang. Our empirical results favor an explanation based on Prospect Theory as introduced by Kahneman and Tversky (1979). Stocks with high levels of idiosyncratic skewness are characterized by low probabilities of high returns which are overweighted. While probability weighting suggests a general overvaluation of stocks with high idiosyncratic skewness, the changing risk-attitudes implied by the S-shaped value function weaken (strengthen) the demand for these lottery-like return profiles in the gain (loss) domain. Investors' desire to break even, when having experienced prior losses, intensifies the preference for lottery-like stocks in the loss domain. Our empirical results are consistent with an overvaluation of stocks with high idiosyncratic skewness, which is induced by a strong demand for lottery-like stocks by Prospect Theory investors who trade at a loss relative to their reference point. We find that this mispricing is especially strong when limits of arbitrage are high and it is likely to be corrected following periods of high investor sentiment, in expansions, and in months and on days when investor mood tends to be low