42 Pages Posted: 26 Mar 2008 Last revised: 10 Jan 2011
Date Written: January 9, 2011
Motivated by range-related trading practices, this paper investigates the return-predictive role of relative price level. As the price of a stock moves to an unusually high or low level with respect to a long-term trading range, concern about mean-reversion in the price becomes important. I test this hypothesis using a mean-reversion-based measure to proxy for the relative price level. Tests show that the measure is a significant and robust predictor of cross-sectional variation in stock returns. The results suggest that in the presence of uncertainty about duration of firm-specific shocks, deviation from a perceived range makes investors conservative, which creates abnormal performance of a "buy high and sell low'' portfolio strategy. The relative price level effect is not driven by small-cap stocks and it is not a manifestation of momentum, reversal, the 52-week high, and volatility effects.
Keywords: Relative price level, mean-reversion, trading range, investor conservatism, underreaction, technical analysis
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