Shunned stocks and market states

Abstract

Hong and Kacperczyk (2009, The price of sin: The effects of social norms on markets. Journal of Financial Economics 93(1), 15–36) document that ‘sin stocks’ (alcohol, tobacco, and gambling) earn relatively high returns on a risk-adjusted basis. We revisit their original study with an updated sample. Contrary to the stylized facts that prominent anomalies attenuate out-of-sample or in the post-publication period (McLean and Pontiff 2016, Does academic research destroy stock return predictability? The Journal of Finance 71, 5–32), we document that the superior performance of sin stocks has persisted over the most recent decade (2009–2018). This is consistent with the increased popularity of socially responsible investing over recent decades, pushing more norm-constrained investors away from sin stocks. Further analyses suggest that sin stocks outperform in low-liquidity states and in high-uncertainty states and are recession-proof. Overall, our work supports the shunned stock hypothesis and indicates the price of sin stocks is alive and well.

KEYWORDS:

• Sin stocks
• social norms
• shunned stock hypothesis
• market states

JEL CLASSIFICATIONS:

• G11
• D71

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 We are aware that there is no universal definition of sin stocks. For example, besides alcohol, tobacco and gaming industries, HK2009 also include the gun industry in their robustness checks because weapons manufacturers are considered by some as promoting human vice, crime, and warfare. Blitz and Fabozzi (2017) also note that there is no consensus on sin stocks, as some researchers adopt a broader definition of ‘vice stocks' by including firms that operate in alcohol, tobacco, gambling, sex-related industries, weapons, military, and even nuclear power sectors (e.g., Lobe and Walkshäusl 2016). We follow strictly the definition of HK2009, so that we could evaluate the out-of-sample and post-publication performance of sin stocks.

2 Throughout the article, we use the terms sin stocks and shunned stocks interchangeable.

3 Over the recent decade, there is an increasing trend across the globe to engage in more socially responsible investing, or more broadly termed as impact investing (see Höchstädter and Scheck 2015). This (increased) emphasis on social or moral impacts could push more investors away from sin stocks, ‘strengthening' the price of sin over time.

4 Adding to the importance of our study is the fact that the recent decade (i.e., 2009–2018) is an interesting period when many conventional investment styles, such as size, value, profitability, and investment, did not offer a positive risk premium (see Fama and French 2020; Blitz 2020).

5 Even though the publication of academic research brings to investors’ attention and increase their awareness of this underpricing-related anomaly, the nature of social norm dictates that arbitrage capital still cannot trade on these sin stocks. The persistence of social norm is like the ‘force' of risk, which will not be easily altered by the publication of academic research. Therefore, it is different from the case of the overpriced-related anomaly, which discerning investors could quickly act on it once they are aware of the opportunity (after the publication of academic research).

6 See for example HHS (Department of Health and Human Services) report ‘The health consequences of smoking—50 years of progress: A report of the Surgeon General.' https://pubmed.ncbi.nlm.nih.gov/24455788/

7 Besides the ‘Triumvirate of Sin', HK2009 also consider the weapon industry (guns) as another candidate of sin stocks, and include it in their robustness checks.

8 According to the U.S. Social Investment Forum (SIF) 1995–2012 biannual surveys, over 90% of the funds use three or more screens to constrain their investments in sinful businesses. The top four screens based on the SIF surveys between 1995 and 2005 were tobacco, alcohol, gaming, and weapons.

9 https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

10 http://people.stern.nyu.edu/jwurgler/

11 https://www.policyuncertainty.com/

12 We caution the readers that there are several caveats when interpreting the results that sin stocks are recession-proof. First, return variations are much larger in recession than in non-recession periods. Second, although we have a 55-year sample, there are only a small number of recessions (i.e., only eight recession episodes in between 1963 and 2018, see Figure 1). Both caveats dramatically reduce the power of two-sample statistical tests, making our interpretation extreme difficult. However, irrespective of our interpretation, the bottom line is that sin stocks do not fare quite as badly as other stocks on a risk-adjusted basis during historical recessions.

Additional information

Notes on contributors

Xing Han

Dr. Xing Han is an assistant professor at the University of Auckland Business School, New Zealand. His research interests revolve around empirical asset pricing and financial markets.

Youwei Li

Dr. Youwei Li is a Professor of Finance at Hull University Business School, UK. Previously, he worked at the Queen's University of Belfast. Professor Li holds a PhD in Financial Econometrics from Tilburg University, the Netherlands, and a PhD in Mathematics from Lanzhou University, China. He has published articles in international journals in areas of asset pricing, investment, longevity risk, market microstructure, and quantitative finance. His research articles can be found on his Google Scholar Profile (https://scholar.google.co.uk/citations?hl=en&user=ePhWkK0AAAAJ), his SSRN Profile (http://ssrn.com/author=539212), and the ORCID website (https://orcid.org/0000-0002-2142-7607).

Olena Onishchenko

Dr. Olena Onishchenko is a lecturer in finance at the University of Otago (New Zealand). She holds a PhD in economics from Poltava National Technical University (Ukraine). Dr. Onishchenko's research interests lie in empirical capital markets, with a particular focus on retail and institutional investors' trading behavior. She has published in peer-reviewed finance and economics journals such as Pacific-Basin Finance Journal, Journal of Behavioural Finance, Journal of Behavioural and Experimental Finance and Journal of Forecasting. In recent years, she has also developed research interests in the role of the securities lending market in asset pricing. Dr. Onishchenko formed a successful research partnership with New Zealand Stock Exchange (NZX) and S3 Partners (New York-based financial start-up). Dr. Onishchenko has been the recipient of numerous Accounting and Finance Association of Australia and New Zealand research grants and internal research grants. Dr. Onishchenko is also a Financial Research Network (FIRN) member.