Extreme daily returns and the cross-section of expected returns: Evidence from Brazil

Abstract

This paper examines whether extreme (positive) daily returns predict the cross-section of monthly stock returns in Brazil. We find a negative effect of the maximum (MAX) daily return on future performance which is in line with the findings from recent studies in the U.S. and Europe. High MAX stocks appear to cater to some investors who are looking for lottery-like stocks, as extreme positive return stocks offer the possibility of substantial gains with a low probability. Increased demand leads to overpricing of and ensuing lower returns to lottery-like stocks. Other proxies for extreme returns, such as idiosyncratic volatility and skewness, play a much weaker role (if any) as cross-sectional determinants of stock performance. We document that the MAX effect is significant only during economic contractions, thus suggesting that the gambling behavior in the stock market exacerbates during economic downturns. © 2017 Elsevier Inc.