Gambling and Stocks

Who Gambles in the Stock Market?

By Alok Kumar

• The concept that gambling motivations may influence investment decisions is not a new notion. Previous studies have linked the role of gambling behavior in shaping investment decisions. This economist cross examined the link between gambling attitudes and stock investment decisions in an effort to explain portfolio volatility across varying socio-economic levels.
• Previous studies have identified skewness preferences as determinants of portfolio under-diversification

Question: Do individuals with lottery/gambling characteristics also exhibit a strong preference for lottery-resembling stocks when they invest in the stock market?

• The existing information on lottery purchases indicate that lottery participation is strongly influences by socio-economic and psychological factors.

• Situational factors relate to people’s perceptions of their economic situation. Situational factors are the perceived constraints under which people operate.

• Relevant factors include: the results of the existing lottery information indicates the heaviest lottery players to be poor, young, uneducated men who live in urban areas and belong to a specific minority (African-American and Hispanic) and religious (Catholic) groups

• Related article describes an amazing trend; while the stock market has been free falling, declining up to 500 points in single day during September 2008, college football betting has been booming with an estimated $41 Billion being wagered on the 2008 season.

What Kumar expected to find

• “Similar to gambling the opportunity, all be it a small one, the lottery provides for an individual to escape poverty can cause that individual to adopt sub-optimal stock market investment strategies. Specifically, investors with a large gap between their current economic standing and their economic aspirations will over invest in risky, lottery-like stocks. These investors hold these stocks not because they are risk seeking, these people can not afford to be prone to risk, but because they want to have a possibility, even an exponentially small one, to reach their economic aspirations. .”

Methodology

• Using end-of-month portfolio position and trading data from a large U.S. brokerage house for six years (1991-1996), Kumar categorized the portfolio depending on: Age, Race, Sex, Location, Total Net Worth, Income, and Religion. Using these categories he would draw conclusions about the portfolio make-up of individuals who exhibited lottery prone characteristics.

Conclusions

• Individual investors invest disproportionately more in stock with higher volatility, higher and higher skewness. Furthermore, individual investors’ demand for lottery-type stocks increase when economic conditions are poor.

• Factors which induce higher expenditures in lotteries also induce greater investment in lottery-type stocks.

• Investors who are pre-disposed to playing lotteries also exhibit strong preferences for lottery-type stocks in their investment portfolio.

These investors on average fared the worst of all investors with disproportionate investment in lottery-type stocks. Investor’s in the lowest income group had an annual under performance of $4725 which makes up 32% of their annual income.

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