A greater proportion of unsophisticated retail traders in lottery stocks means greater noise trader risk and thus higher arbitrage risk.
This persistence is likely due to lottery stocks' noise trader risk. A larger retail trading proportion in lottery stocks increases the probability that irrational noise traders will contribute to a stock's deviation from fundamental value, which represents an arbitrage risk.
Waldmann, 1990, "Noise Trader Risk
in Financial Markets," Journal of Political Economy, 98, 703-738.
Waldmann, "Noise Trader Risk
in Financial Markets" Journal of Political Economy 98, pp.
Bradford De Long et al., Noise Trader Risk
in Financial Markets, 98 J.
Noise trader risk
similarly reduces arbitrage effectiveness because arbitrageurs bear the risk that noise traders will continue to be irrational, therefore maintaining, or even increasing, the mispricing.
For example, he explains how the mispricing of closed-end funds is the logical consequence of arbitrage limited by noise trader risk
. Unless the arbitrager has an infinite horizon and is never forced to liquidate, an arbitrager who buys a closed-end fund at a discount to net asset value while selling short its underlying portfolio (even if feasible and costless) will likely not have an effective arbitrage opportunity.
'Noise Trader Risk
in Financial Markets', Journal of Political Economy, 98, 703-38.
The above setting also holds when the individual smart trader is risk-averse and there exists uncertainty with regard to the firm value (fundamental risk) and noise process (noise trader risk
Morck, Yeung, and Yu propose that weak private property rights impede informed trading and increase systematic noise trader risk
. They also conjecture that, in countries that protect public investors poorly from corporate insiders, intercorporate income shifting may make firm-specific information less useful to risk arbitrageurs and therefore impede its capitalization into stock prices.