Learning from Noise: Evidence from India’s IPO Lotteries

Abstract:  We study a natural experiment in which 1.5 million investors participate in allocation lotteries for Indian IPO stocks between 2007 and 2012. Random gains on these stocks cause winning investors to increase applications to future IPOs, tilt portfolios towards the IPO’s industry sector, and substantially increase portfolio trading volume in non-IPO stocks relative to lottery losers. Effects are symmetrically negative for experienced losses, and decline monotonically with the number of past IPO allocations received. We consider a number of different models; the evidence is most consistent with investors learning about their own ability from experienced noise, drawing inferences about their skill from luck. These results suggest that economic agents learn about their own ability from noise shocks, though repeated exposure to these shocks and/or selection can significantly attenuate these responses.