Saving the Speculative Markets from the Speculators

We examine important consequences of investor preference for stocks with lottery-like payoffs. Specifically, the participation of investors seeking lottery-like payoffs increases the demand for Initial Public Offerings (IPOs), thus increasing IPO prices and potentially affecting firms’ decision to go public. Our study is based on a natural experiment, in which the price moves of newly-listed IPO stocks are restricted within a narrow range, reducing the short-term upside potential for investors and limiting their ability to gamble. Pursuant to the introduction of these restrictions, investors with a preference for lottery-like payoffs reduce their participation in IPOs and their net buying in the IPOs’ aftermarket. The reduced aftermarket demand is followed by an increase in subsequent returns of IPO firms, consistent with reduced asset prices. We also document a disappearance of IPOs most affected by the imposed price restrictions. Our overall findings shed new light on the role of speculative investors in equity markets, suggesting that the participation of such investors may increase prices in a market generally afflicted by high asymmetric information problems.