Penny Wise, Dollar Foolish: The Left-Digit Effect in Security Trading

Abstract:     
In grocery stores, we see many prices at $2.99, $9.99, $19.99; in car lots, mark-downs to $5,990, $9,990, $19,990 are pervasive; in residential real estate, it is popular to list homes at $99,000, $299,000, $999,000. This paper asks whether this left-digit effect – the propensity to anchor value on the left digits – exists in security trading as well. We find that it does. Using a random sample of more than 100 million stock transactions, we find that that the ratio of buys to sells by liquidity demanders is highest at prices ending at .99 and lowest at prices ending at .01. This effect exists unconditionally, and is stronger conditionally (conditioned upon whether prices penetrated an integer from above or below). Further tests, such as the finding that liquidity demanders with a left-digit bias lose about $90 million a year, rule out the alternate hypothesis that value trading predominately explains our findings. Finally, and surprisingly, we find that observed liquidity suppliers are also susceptible to the left-digit effect: they offer more depth to buy than sell at .99 and .49, and more depth to sell than buy at .01 and .51. The implication is that unobserved liquidity suppliers (floor broker orders, behind-the-market limit orders, hidden orders, etc.) exploit the left-digit effect.

Keywords: Price clustering, left-digit effect, nine-ending prices, trading strategies

JEL Classifications: C15, G12, G20

Working Paper Series