Behavioral, Psychological and Socio- Economic Factors to Seeking Risk on the Stock Market or in the Gambling Den
Zusammenfassung
To answer these questions the following paper is organized as follows. Section 2 provides the theoretical foundation for the analysis by defining gambling in a traditional sense and providing a framework for identifying gambling on the stock market. Section 3 analyses the motives for traditional gamblers and those on the stock market and links them to certain personality traits as well as socio-economic status. Section 4 briefly sums up the most important findings, compares differences and similarities between the two distinct groups and concludes.
Leseprobe
Table of contents
List of tables
1 Introduction
2 Theoretical Framework
2.1 Gambling in a Traditional Sense
2.2 The Relationship of Gambling, Financial Speculation and Investing
2.3 Gambling on the Stock Market
3 A critical Analysis of People's Motives for Engaging in Gambling traditionally and on the stock market and their Demographics
3.1 Framework of the Analysis
3.2 Motivational Factors for participating in Traditional Gambling
3.3 Socio-economic Status and Personality Traits of the Prototypical Gambler
3.4 Motivational Factors for participating in Gambling on the Stock Market
3.4.1 Overconfidence
3.4.2 Recreation or leisure Gambling
3.4.3 Sensation Seeking
3.5 Socio-economic Status and Personality Traits of Stock Market Gamblers
4 Conclusion
Bibliography
List of tables
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1 Introduction
“I like the stock” - with this statement to the House of Financial Committee by Keith Gill, better known by his Reddit profile name ‘u/DeepFuckingValue' the rise and collapse of the GameStop stock took its highlight in public interest (Matthews (2021)). In the previous weeks, the GameStop stock increased rapidly in its price from $15.80 per share on 1st of December 2020 to an intra-day high of $483.00 on 28th of January 2021, which is a factor of 30.5x in roughly two months (CNBC Markets (2022)). While the exact reason for the price explosion remains subject of current research, first evidence shows it could have been heavily influenced by retail investors organized via Reddit (Abhinav and Pathak (2021)). However, this is not the only example of retail investors speculating in financial markets. As of December 1st 2021 the total market capitalization of so-called ‘meme coins' is about 44 billion dollars (Coinmarketcap (2021)). These coins named ‘Dogecoin', ‘Loser Coin' or ‘DogeElon Mars' with mostly no real utility and created for ‘fun' have combined more than twice the market value as the equity of Deutsche Bank (CNBC markets (2021))1. As restrictions for professional and institutional investors suggest, these meme-coins must be mainly bought by retail investors.
The social costs and negative side-effects of gambling in a traditional sense, such as sports bets, casino games or lottery have been subject to extensive research in the field of psychology and behavioral finance for decades (National Gambling Impact Study Commission (1999); Walker and Barnett (1999)). In contrast, the economic implications of retail investors gambling in financial markets remains a relatively controversial field of study. Although there is evidence that gambling-like behavior of private investors has harmful effects in terms of monetary outcome. For example, Kumar (2009) finds evidence, that retail investors who engage in gambling-like behavior on the stock market (by allocating one-third of their portfolio to lottery-type stocks) underperform a diversified portfolio by 2.5% p.a. on average. In addition, according to Dorn and Sengmueller (2009) excess portfolio turnover can be explained by retail investors trading financial assets for fun. This ultimately leads to potential underperformance through additional trading costs (Barber and Odean (2000)). However, aging populations of developed countries and overall demographics draw increased attention to private retirement planning. Therefore, understanding the underlying motivational factors for retail investors participating in stock market gambling and linking them to a certain demographic profile is an important subject to household finance. That leads to the following three research questions which will be examined in this seminar paper:
1. What are the motivating factors for retail investors who seek excessive risk on the stock market and how do they relate to those of gambling? In other words: why do some retail investors gamble on the stock market and do these reasons apply to other forms of gambling?
2. Who are these gamblers on the stock market in terms of socio-economic status and personalities? Are they different to those participating in other gambling markets? Which potential similarities exist between these groups?
3. Do people participate in gambling because they prefer risky investments (sensation seeking) or are they misjudging the odds of winning (misled belief)?
To answer these questions the following paper is organized as follows. Section 2 provides the theoretical foundation for the analysis by defining gambling in a traditional sense and providing a framework for identifying gambling on the stock market. Section 3 analyses the motives for traditional gamblers and those on the stock market and links them to certain personality traits as well as socio-economic status. Section 4 briefly sums up the most important findings, compares differences and similarities between the two distinct groups and concludes.
2 Theoretical Framework
2.1 Gambling in a Traditional Sense
As a prerequisite of studying gambling behavior in any sector, it is necessary to understand what ‘gambling' is, which specific activities are included and which are not. In addition, there are several different types of gambling. The following section is therefore providing a definition and explains what is subsumed under traditional gambling in this paper. Potenza et al. ((2002), p 1.) define gambling in the broadest sense as „placing something of value at risk in the hopes of gaining something of greater value”. This definition is in line with Williams et al. (2017) who summarize a variety of academic and institutional gambling definitions. According to their work, a gamble requires three properties to be clearly classified as such. First, consideration which represents the amount wagered on an event by the gambler. Second, risk as the possibility of losing the amount wagered as well as uncertainty about the outcome. Third, a prize which compensates the better in the event of winning the gamble. However, there is no commonly agreed upon academic definition of gambling. Scholars argue if a gamble needs to fulfill additional properties such as the event being purely random or chance-driven, whether gambling creates no economic utility and whether having a negative mathematical expected value is necessary.
In practice, gambling appears in many different forms. Typically, lottery-style games, wagering games like sports or horse betting, electronic gaming devices and chancebased casino games are classified as gambling. They can be offered via online formats, in a physical way or sometimes hybrid forms (Binde et al. (2017)). These different gambling types can vary heavily in terms of their structural characteristics (Parke et al. (2016)), but they all share the three core elements provided in the definition. In addition, these different forms of gambling come with different payout profiles or playing experiences. For example, lotteries, which are considered as ‘long-odds' games, offer a huge prize in comparison to a small stake. In contrast to that, most wagering games, which are considered as ‘short-odds' games, offer a possible gain which is near the amount of the person's stake (Williams et al. (2017)). Regarding playing experience, Bingo is often accompanied with a form of social interaction, while casino games like poker are associated with a level of perceived or actual skill. Furthermore, behavioral studies suggest that the probability of developing a problematic or even pathological gambling behavior is different across the various gambling types (Balodis et al. (2014)). However, this paper will not differentiate between leisure and problem gambling.
2.2 The Relationship of Gambling, Financial Speculation and Investing
With the three core properties of a gamble and practical examples of gambling activities in mind, the goal of the following section is to apply that knowledge to financial markets. The boundary between gambling and investing money in financial markets seems to be blurred in some places. For example, in two independent studies asking 12.843 North American adults Williams et al. (2017) show that 36.5% of the study participants consider buying ‘Blue Chip' stocks as a Gamble. The evidence for “HighRisk Stocks” is even higher with 57.2%. However, if one compares the public perception of the two concepts, Investing and Gambling appear to be fundamentally different. Investing is usually described as a sensible thing to do with a long-term focus and possible capital appreciations along the way. On the other hand, Gambling is typically connotated as an activity carrying high risks of financial losses and addiction (Arthur et al. (2016)). Comparing the definition of gambling to that of investing, e.g. by Bogle (2012) who describes investing as an activity of buying or placing money on an asset with the expectation of long-term capital growth or other financial benefits (like dividends) from that asset, clarifies the fundamental differences: First, staking of the investment is not explicitly formulated, although some financial assets bear the risk of total capital loss. Second, the outcome of an investment has no direct link to a specific event. Third, the long-term focus with investment horizons of decades especially in retirement planning. Fourth, the positive expected value for investments (even though this is not included as a necessary property of a gamble most gambling activities have a negative expected value). The concept of financial speculation places somewhere in between investing and gambling. It usually refers to short-term oriented trades, carrying higher idiosyncratic risk and with the goal of making a profit regardless of the capital appreciation of an underlying asset (Arthur and Delfabbro (2017)). For example, buying high-risk stocks, shorting a stock or day trading are typically described as financial speculation.
2.3 Gambling on the Stock Market
After defining and explaining the conceptual differences of gambling and investing the following chapter provides a framework to understand what is meant by gambling on the stock market. In the broadest sense this term suggests that investors participating in it show motivational factors and behavioral patterns similarly to those people (virtually) attending a gambling facility. They would buy and sell financial assets for example as entertainment, in a sensation-seeking behavior or in an (misled) aspiration for riches. Put simply, investors treat the stock market like a casino and picture these activities as substitutes. In order to quantify this phenomenon Alok Kumar (2009) developed an empirical definition of lottery-type stocks which is widely used across consecutive academic work in that topic (Dorn and Sengmueller (2009); Dorn et al. (2014); Gao and Lin (2015)). Therefore, the following section is largely based on his work. Investors who trade or hold securities with the following properties in disproportional amounts work as a robust proxy for investors seeking a lottery-like payoff in the stock market. However, as linking trading behavior in specific securities to trading motives or even socioeconomics of the individual buyer/seller is difficult, chapter 3.3 uses excessive trading per se as an additional proxy.
Kumar points out three stock characteristics which can be used as identifiers for lotterytype stocks:
1. Individual stock price
2. Stock-specific / idiosyncratic positive skewness
3. Stock-specific / idiosyncratic volatility
Starting with the easiest observable property, the price. If individual investors seek to achieve a lottery-like payoff, they should draw increased attention to low-priced stocks by intuition. These low-priced stocks (or penny stocks) are recognized very much like a lottery ticket, as they carry theoretically infinite upside potential (no matter how unlikely this is, there is no upper limit to stock prices) for a cheap price. The preference for stocks with a return distribution showing positive idiosyncratic skewness should result from investors extrapolating past returns on the future. Within the range of cheap stocks, they are searching for stocks which generated extreme positive returns on past events, disregarding that these stocks will likely cause more frequent losses to the investor. Ultimately, in the subset of low-priced stocks with high stock-specific skewness, investors should prefer stocks with high stock-specific volatility. The intuition behind this is that investors may believe that these high-volatility stocks have a higher probability of generating the extremely positive returns on past events again. In addition, high idiosyncratic volatility could amplify the preference for positive skewness, if investors focus on upside volatility rather than downside risk. In sum, investors seeking a lottery-like payoff through their stock investments, buy stocks, which have shown extreme positive returns in the past (skewness), which trade at a cheap price in absolute numbers and which show a high variation in their returns 5 (idiosyncratic volatility). Table 1 indicates empirical characteristics of lottery-type stocks from an analysis of total CRSP universe stocks from 1991-1996 by Kumar.
Table 1: Lottery-type stock characteristics. Adjusted representation of Table II in Kumar (2009). The table displays the mean monthly characteristics of lottery-type stocks, nonlottery-type stocks and others from the sample period 1991-1996 of the CRSP universe.
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These stocks have a 3.7% lower past 12-month return compared to non-lottery stocks, only 3.37% are dividend paying and they show a high monthly share turnover. Additionally, lottery-type stocks have a significantly lower market capitalization with an average of $31 million as well as low institutional ownership of 7.35% (supporting the hypothesis that gambling in financial markets is mainly driven by private investors). Regarding portfolio aspects, Kumar (2009) states that the average level of underperformance for investors allocating one-third of their portfolio to lottery-stocks amounts over 2.5% p.a. on a risk-adjusted basis.
3 A critical Analysis of People's Motives for
Engaging in Gambling traditionally and on the stock market and their Demographics
3.1 Framework of the Analysis
Both research fields, as compared in the following analysis contain a variety of subsections with partly heterogenous properties. Hence, it is necessary to set a focus by putting emphasis on selected topics. The guiding principle for setting focus in this present paper is the consideration of which traditional gambling activity could potentially have the greatest similarities to the gambling activity on the stock market as described in section 2.3. This approach should improve the overall comparability of the results regarding motivational and socio-economic factors and should enable the transfer of regulatory implications from one field to the other. That is why section 3.2 concentrates particularly on socio-economic status of lottery players and sports betters. The reasons for this choice are as follows: Playing the lottery could serve as a good basis for comparison mainly due to its relatively similar payout profile to lottery-type stocks (Kumar (2009)). The lottery, as a long-odds game, offers high payout in relation to the ticket which shows parallels to the concept of cheap priced lottery-type stocks described in 2.3. In addition, lottery studies show an extensive track record of academic research related to motives and socioeconomics of participants (Ariyabuddhiphongs (2011)). Furthermore, lotteries amount for the highest gambling participation rates attributable to a specific gambling type, e.g. they show the highest prevalence rates (Welte et al. (2002)). On the other hand, similarities between stock market gambling and sports betting might exist in terms of conceptual context as well as time horizon. For instance, the discretionary stock-picking in which lottery-type investors engage can be compared to the idea of betting on the right team or horse in a sports betting context. Moreover, the extended time horizon of for example seasonal or combinational bets, could match the average holding period of lottery-type stocks more accurately. However, this is just an assumption by the author.
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1 On due date of this paper (10.01.2022) this numbers are closer together with crypto markets declining in value and recent price appreciation of the Deutsche Bank stock, however the message remains the same.