Maxing Out Globally: Individualism, Investor Attention, and the Cross Section of Expected Stock Returns

We examine the role of cultural difference in the pricing of positive extreme returns (MAX) for 47,000 stocks from 42 countries from 1990 to 2012. We find that investors overpay for stocks with high MAX and that MAX-premium, the spread from long-short strategy based on low- and high-MAX stocks, is both statistically and economically significant worldwide. The negative relation between idiosyncratic volatility and expected returns, or idiosyncratic volatility puzzle, exists only for stocks with high MAX, implying that the puzzle may arise from the overpayment for stocks with high MAX and the subsequent return reversal. Consistent with the expectation that overpayment will be stronger for overconfident investors, the MAX-premium is larger in countries with high individualism index (IDV) than it is in countries with low IDV. Furthermore, we find the MAX-premium to be larger and the difference in the MAX-premium between high- and low-IDV countries to be more pronounced when VIX and volatility are high. Our findings suggest that the attention-grabbing feature of stocks with high MAX affects the pricing of extreme positive returns asymmetrically depending on the cultural differences across countries. History: Accepted by Lauren Cohen, finance. Funding: K.-H. Lee thanks the Institute of Management Research and the Institute of Finance and Banking at Seoul National University for financial support. This work was also supported by Incheon National University [Research Grant 2014-0877], Keywords: individualism * culture * sentiment * attention * international finance * lottery * extreme return * idiosyncratic volatility
1. Introduction Financial economics is the discipline in which cross-cultural analysis has been least welcomed (Hofstede 2001), (1) and 'most of contributions [linking finance and culture] are published within the [...]