Asset Pricing in the Dark: The Cross Section of OTC Stocks

Abstract:     
Compared to listed stocks, over-the-counter (OTC) stocks are far less liquid, disclose less information, and exhibit lower institutional holdings. We exploit these different market conditions to test theories of cross-sectional return premiums. Compared to return premiums in listed markets, the OTC premium for illiquid stocks is several times higher, the OTC premiums for size, value, and volatility are similar, and the OTC premium for momentum is three times lower. The OTC premiums for illiquidity, size, value, and volatility are largest among stocks that are held almost exclusively by retail investors and those that do not disclose financial information. Theories of differences in investors' opinions and short sales constraints help to explain these return premiums. Our momentum results are most consistent with Hong and Stein's (1999) theory based on the gradual diffusion of information.

Number of Pages in PDF File: 76

Keywords: Illiquidity Premium, Limits to Arbitrage, Over-the-Counter Markets, OTC Stocks, Pink Sheets, Bulletin Board, Disclosure, Return Anomalies

JEL Classification: G10, G12, G14

working papers series