Investor sentiment and the MAX effect: evidence from Korea

Stocks with extreme positive returns underperform the market since they are overpriced due to investors' preference towards lottery-like stocks, stocks with a low probability of an extremely high payoff. Using data from the South Korean stock market, we show that the underperformance of such stocks is pronounced following periods of low investor sentiment. This suggests that low investor sentiment coincides with economic downturn when stocks with extreme positive returns experience increased salience and attention. We provide supporting evidence that stocks with extreme positive returns experience a substantial increase in trading volume and buying pressure from individual investors when investor sentiment is low.