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OPINION

It's a gamble

It's a gamble
August 28, 2015
It's a gamble

Alok Kumar at the University of Miami and economists at Warwick University measured fluctuations in such attitudes by how often people searched for the word 'lottery' in Google. They found that when there were a lot of searches - which tended to coincide with big jackpots - lottery-type stocks (those with low prices and high idiosyncratic volatility) subsequently did well. "Shifts in overall gambling attitudes have a spillover effect on the stock market," they conclude.

This is corroborated by separate research by Chi Liao at the University of Manitoba. She shows that when a new casino opens in the US, investors who are likely to use it also increase their risk exposure in their equity holdings, for example by buying higher-beta shares.

These might seem like low-level curiosities. But they might not be. They are consistent with three bigger facts about stock markets.

One is seasonality. The UK's biggest gambling events have traditionally occurred in the spring - the Cheltenham festival in mid-March and the Grand National in April - perhaps because lighter nights make us more willing to take risk. Is it a coincidence that stock markets tend to do well in March and April, only to slip back later?

Another is the financial instability hypothesis proposed by the late Hyman Minsky. He suggested that long periods of stability are inherently destabilising because they encourage companies and investors to take on more risk. This is consistent with good times leading to an increasing willingness to gamble.

Thirdly is Robert Shiller’s theory that share prices depend upon social psychology. Ulrike Malmenider and Stefan Nagel have shown that our attitudes to risk are shaped by our experiences in our formative years: people who experience recession when they are impressionable are less likely to take risk even decades later.

This might help explain long swings in share prices. Perhaps the bull market of the late 60s and early 70s occurred because investors who had been scarred by memories of the Great Depression retired and were replaced by people who had known only the long post-war boom and so were more willing to take risk. And perhaps the stagnation of the post-tech crash years has been due in part to the fact that corporate decision-makers' spent their formative years in the 70s and 80s and so have been reluctant to take equity risk.

It's a commonplace that day-to-day variations in share prices are due to changes in appetite for risk. The same might be true of much longer-term swings.