Review of Who gambles in the stock market?

by Kumar (2009)

Overview

The paper discusses the role gambling behavior among individual investors in explaining their
investment choices. The author argues that demand for stocks which have characteristics of
lotteries can be explained as the result of socioeconomic and regional factors which are associated
with gambling behavior of individuals. Building on the studies which identify common factors
associated with lottery spending and studies on lottery-stocks, the paper builds the narrative in four
successive themes: Individual versus Institutional Preference for lottery-investment, preference
among various socio-economic groups and regions known to prefer gambling, change in
preference due to macroeconomic factors, and lastly, whether lottery-investment has adverse
impact on portfolio performance i.e. returns from lottery-stocks. Accordingly, the author reports
four key findings from the study: a) institutional investors are less likely to prefer lottery stocks,
b) socioeconomic and regional factors associated with greater spending on lottery tickets, exhibit
similar relationship with investment in lottery-stocks, c) incidence of engaging in lottery stocks
increases during downturns, and d) characteristic of lottery-stocks which usually underperform,
portfolios overweighed with lottery stocks show dismal returns and individuals with such
portfolios exhibit low-income.

The paper primarily contributes to behavioral finance and asset pricing literature. Firstly, the paper
identifies the characteristics of investors which exhibit an excessive demand for lottery stocks and
traces such investment behavior of investors to socioeconomic factors. This finding provides a
vital building block for scholars in behavioral finance to explore more factors which can
significantly impact the investment behavior of individuals but lie outside the realm of financial
markets. Secondly, though not recognized by the author of the paper, the evidence for a preference
for lottery stocks can potentially explain the beta anomaly identified by prior literature.

The paper is well-written and communicates to the reader in a seamless and lucid manner. The
empirical results are interesting and robust to alternative specifications. However, some concerns
related to the paper are summarized in the following points:

Contributions to the literature have not been explicitly stated in the introduction section.
 The author does not clarify the term "stock category" used in the variable definition of
"Percentage dividend paying" and "% Without analyst coverage" in Table 1.

Independent variables are likely to be correlated. E.g. The two variables in Panel F of Table
1. The correlation matrix for the variables has not been reported.

The author makes an important assumption that only when people's gambling demands are
unsaturated, they will exhibit a preference for the lottery in their investment (pg. 1893). It
can be argued that one need not make this assumption. If lottery-preference is a personality
trait of the individual, then the first assumption is very restrictive. Here, one would have to
also comment on the level of saturation and how the individual achieves the saturation.
However, the author can use Thaler's concept of mental accounting in justifying the
behavior of individuals who prefer state lotteries as well as invest in lottery-like stocks as
they consider them to be two different uses of their money.

The paper uses individual account data from a discount brokerage house, to conclude that
investors with a higher gambling tendency are also more probable to invest in lottery-
stocks. However, the data does not allow the author to answer whether gamblers in an area
are more likely to participate in the stock market. Further, whether an investor is a gambler
or not cannot be answered by the discount brokerage data. Here, the author has to estimate
the likelihood of an investor of being a gambler using demographic and socioeconomic
characteristics, which can be inaccurate. This limitation of the analysis must be explicitly
stated by the author.

The author hypothesizes that individual investors have a taste for stocks with lottery-like
payoffs. However, such behavior is different from the sensation-seeking (or entertainment)
of investors. Individuals may trade to amuse themselves but might hold well-diversified
portfolios and avoid lottery-like stocks. However, investors with a preference for skewness
will still hold a lottery- stocks but may not trade. The author must provide relevant
comments to clarify the same.

No comments on the empirical methodology at all.. A review is possible only when there
is a summary. Where is the summary of the paper?
Your understanding level has not progressed to a level yet where you can not provide a
summary and still do a good job. Because you have not provided a summary, your work
and effort lacks depth and looks shallow. This kind of work, is below par for an FPM
student in the final Term.