Recent research by Dr. Scott Murray, assistant professor of finance, has garnered substantial attention from the finance community. Dr. Murray has been invited to present this work at several prestigious events attended by top finance practitioners such as hedge fund and mutual managers, as well as leaders in the academic finance research community. Over the next few months, Dr. Murray and his co-authors will showcase their work at the Q-Group (The Institute for Quantitative Research in Finance) spring seminar, the Society for Financial Studies Cavalcade conference, and the Western Finance Association Meeting, which accepted only 144 of more than 1700 papers submitted. They have also been awarded the Q-Group’s Jack Treynor prize for superior research with applications in the field of investment management.
The article describing their work, titled “Betting against Beta or Demand for Lottery,” examines a well-known but not well understood phenomenon in stock returns. The foundational theory of risk and return, known as the Capital Asset Pricing Model (CAPM), predicts that high-risk stocks should, on average and in the long run, generate higher average returns. Previous research examining stock returns over the past 50 years, however, has failed to detect such a relationship. Murray and his co-authors’ major contribution is to provide an explanation for this puzzling disconnect between financial theory and what has actually occurred in the financial markets.
The “Betting against Beta or Demand for Lottery” article explains that some investors have a preference for lottery-like stocks, or stocks that have a high probability of realizing a large price increase in the short-term future. Such lottery stocks also happen to be high risk stocks. The trading activity of lottery stock investors puts upward price pressure on high-risk stocks, causing such stocks to become overvalued. As a result of this over-valuation, the future returns generated by lottery (high-risk) stocks are abnormally low. Murray’s research demonstrates that once the effect of lottery demand is accounted for, the theoretically predicted relation between risk and returns emerges.