Why Investors Chase “Lottery Stocks” That Consistently Underperform

Why It Matters

Investors often flock to stocks that historically underperform, the so-called “short-leg securities.” Understanding why they do so sheds light on the behaviour of investors and, by extension, that of financial markets.

Key Takeaways

• Investors are drawn to “short-leg securities” despite their consistently low returns.
• Textual analysis of analyst reports and investment blogs shows that buy recommendations primarily highlight their lottery-like upside potential.
• Surveys of institutional and retail investors confirm this preference and search for stocks that may become the next Amazon or Netflix.
• All in all, it appears that speculative excitement, not fundamentals, drive demand for these stocks.
  

Why Investors Favour Short-leg Securities

Short-leg securities are stocks that, according to decades of asset-pricing research, tend to deliver unusually poor future returns. Traditional finance theory, which assumes investors act rationally, struggles to explain why such low-performing assets continue to attract buyers.

This study explores the puzzle by analysing over 1.7 million analyst reports and 140,000 opinion pieces from Seeking Alpha, an online investment community. It investigates how financial commentators justify buy recommendations for these underperforming stocks and what language they use to describe them.

Textual Evidence from Analyst Reports and Blogs

The research team examined the words and themes used in buy recommendations for short-leg securities. They tested whether analysts and bloggers emphasised safety, perceived momentum and superiority, or speculative, lottery-like payoffs.

The results were clear: while some recommendations mentioned stability or supremacy, the dominant theme was the promise of huge upside. Analysts and bloggers frequently used language such as “gamble,” “speculate,” or “upside.”

This language signals that even professional market commentators frame these investments more as bets.

Survey Validation

To test whether these findings reflected real investor beliefs, the researchers conducted surveys with both institutional and retail investors holding long positions in short-leg securities.

The surveys revealed strikingly similar attitudes.

• 64% of institutional investors and 81% of retail investors cited “upside potential”, rather than stability or momentum and superiority, as their main reason for buying these stocks.
• Many explicitly described their investments as “lottery-like opportunities,” mirroring the speculative tone found in the analyst and blogger commentaries.

This consistency between textual evidence and survey results validates the notion that many investors, both professional and individual, are motivated by the thrill of possible large gains rather than rational expectations of steady returns.

Interpretation and Contribution

The findings point to a clear behavioural explanation. Just as individuals buy lottery tickets even when knowing that the odds are against them, investors appear drawn to certain stocks for their slim chance of extraordinary payoffs.

This “lottery preference” helps explain why many short-leg securities are overpriced and why their poor performance endures over time – just as with lottery tickets, investors usually lose, but the allure of potentially outsized returns keeps demand alive.

Beyond the behavioural insights, the study also showcases the value of textual analysis as a research method. By systematically analysing the language in analyst reports and investment blogs, researchers can efficiently detect shifts in investor sentiment across time and market conditions. This approach offers a scalable and cost-effective alternative to traditional surveys, helping scholars and policymakers track how narratives drive market behaviour.

Business Implications

The results offer a double-edged insight. Firms with lottery-like characteristics, such as small, volatile, or speculative stocks, may enjoy investor enthusiasm and inflated valuations.

For regulators, financial educators and investors, however, the findings serve as a cautionary note. The tendency for investors, including professionals, to chase unlikely payoffs suggests that market inefficiencies stem not only from lack of information but also from human psychology. Investor education should therefore go beyond financial literacy to include awareness of behavioural biases and the emotional pull of “big win” narratives.

 

Authors & Sources
Authors: Hailiang Chen (University of Hong Kong), Byoung-Hyoun Hwang (NTU Singapore), and Zhuozhen Peng (Central University of Finance and Economics).
Original Article: The Review of Financial Studies

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