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The Role of Psychological Barriers in Lottery-Related Anomalies

Abstract It is well documented that stocks with lottery-like characteristics are overpriced. We find that the lottery-related anomaly exists primarily among stocks that are far from their 52-week high prices. When implemented among such stocks, the strategy of buying the least lottery-like stocks and selling the most delivers a significantly positive risk-adjusted return of 2.22% per month. In contrast, it yields an insignificant negative return of -0.31% per month for stocks near their 52-week high. The pattern holds after controlling for capital gains overhang and idiosyncratic volatility. We also find that investors’ optimistic earnings forecasts for lottery-like stocks are attenuated by their nearness to the 52-week high. Our findings suggest that investors consider the 52-week high as the upper price limit and that this psychological barrier affects their preferences for lottery-like stocks.