Previous research has revealed “sin stocks” (stocks from the alcohol, tobacco, and gaming industries) in North American and European stock markets to be underpriced, and the authors explore whether the same is true for sin stocks that include stocks from the defense industry in the Pacific Basin. They find that sin stocks are overpriced in some Pacific-Basin countries and suggest that they are more overpriced when a culture is collectivistic rather than individualistic.
What’s Inside?
Previous studies have demonstrated that “sin stocks” (alcohol, tobacco, or gaming) are underpriced in North American and European markets because of social norms that prevent institutional investors from holding such stocks. The authors investigate whether a similar result occurs in Pacific-Basin countries—namely, Australia, India, Japan, South Korea, Malaysia, New Zealand, and Singapore. They include defense industry stocks as an additional category for sin stocks, with all other stocks (except financials) categorized as non-sin stocks.
They find that almost all of the Pacific-Basin countries overprice sin stocks. They posit (but do not directly test) that collectivist cultures, where the group is viewed as more significant than the individual, tend to overprice sin stocks more than individualistic cultures.
How Is This Research Useful to Practitioners?
The authors’ conclusion that sin stocks are overpriced in some Pacific-Basin countries may lead investors to consider avoiding or even selling short sin stocks in these markets. Assuming the reverse is true in U.S. and European markets (as has been suggested by previous research), long positions in sin stocks in those markets could also be viable. Taken together, a potential long–short investment strategy could emerge.
How Did the Authors Conduct This Research?
Using monthly return and accounting data from 1990 to 2009 from Thomson Reuters Datastream, the authors categorize stocks from the alcohol, tobacco, gaming, and defense industries as sin stocks and stocks from all other industries, except the financial industry, as non-sin stocks. The authors first examine the proportion of sin stocks relative to all other stocks that institutional investors in Pacific-Basin countries hold. The proportion of shares held by entities with 5% or more of outstanding shares is a dependent variable, and a dummy variable for sin stocks serves as the key independent variable while controlling for other factors, such as size, risk, and return performance.
The coefficient for the sin stock dummy variable is negative and statistically significant for Australia and New Zealand, which was expected given those countries’ similarities to the United States. But the sin stock dummy coefficient is positive and statistically significant for Japan and South Korea. One possible explanation, which is not directly tested, is a cultural factor: Japan and South Korea are believed to be more oriented toward collectivism (i.e., a desire to be part of a group) than individualism (i.e., a desire to act more independently).
By running regressions on subperiods (1990–1994, 1995–1999, 2000–2004, and 2005–2009), the authors demonstrate that the results from Japan and South Korea are indicative of recent times, whereas the results from Australia and New Zealand are most reflective of the 2000–04 period. A similar regression is performed using the proportion of shares held by government institutions as the dependent variable. The coefficient on the sin stock dummy variable is positive and statistically significant for Japan but negative and statistically significant for India. The authors posit that the willingness of Japan’s government to invest in sin stocks may be what motivates others in Japan to invest in sin stocks as well.
The authors next examine the risk-adjusted return performance and relative valuation of sin stocks in comparison with all other stocks. Using a multifactor pricing model, the authors find that sin stocks statistically underperform all other stocks on a risk-adjusted basis in five of seven markets. Using the market-to-book ratio as a measure of relative performance, the authors find that sin stocks exhibit statistically higher valuations relative to all other stocks in six of seven markets.
Further regression analysis reveals another possible relationship: The more collective a culture is, the more sin stocks are overpriced. But this relationship is not directly tested by the authors. Sin stocks are also found to underperform in the more individualistic Pacific-Basin countries, similar to U.S. and European markets.
Abstractor’s Viewpoint
I find it interesting that Pacific-Basin markets tend to overprice sin stocks. But the connection between collectivistic cultures and overpricing sin stocks seems tenuous and, at best, a casual observation because of a lack of statistical testing. More investigation is necessary if a particular cultural designation is to be considered the cause of a systematic market behavior.