Extrapolation Bias and the Lottery Effect: Evidence from Cryptocurrency Markets

Abstract

We document a pronounced lottery effect in cryptocurrency markets, where tokens with extreme positive returns experience significant subsequent underperformance. We provide evidence that investors overestimate performance persistence, leading to a more pronounced mispricing when lottery-like payoffs occur recently. The anomaly is amplified among costly-to-arbitrage cryptocurrencies due to trading frictions and transaction costs. Using on-chain and social media metrics, we analyze investor activity and find that extremely strong performance attracts disproportionate attention, amplifying behavioral biases. These results highlight how attention-driven demand, combined with investor extrapolation bias, generates cross-sectional predictability that remains difficult to exploit due to transaction costs and liquidity constraints.

Download

• Working Paper

Citation

Bianchi, Daniele, and Mykola Babiak. “Extrapolation Bias and the Lottery Effect: Evidence from Cryptocurrency Markets.” Working paper.

@unpublished{BB25b,
@article{babiak2025extrapolation,
  title={Extrapolation Bias and the Lottery Effect: Evidence from Cryptocurrency Markets},
  author={Babiak, Mykola and Bianchi, Daniele},
  journal={Available at SSRN 5315949},
  year={2025}
}