Investor Preferences, Stock Prices, and Returns

Abstract

Motivated by retail investor preferences and non-proportional thinking associated with low price stocks, we examine the cross-sectional significance of nominal prices for similar size firms. We find that stock prices controlled (orthogonalized) for size (Oprice) do matter in predicting future stock and delta-hedged option returns. In particular, high Oprice stocks outperform low Oprice stocks by a 5-factor alpha of 0.43% per month (or 5.28% annually). Furthermore, the underperformance of low Oprice stocks is more negative for stocks with (i) high past returns, (ii) high individual investor preference, (iii) higher investor sentiment, and (iv) low institutional ownership. These results are robust to transaction costs and are also evident in a longitudinal setting, following earnings announcements.

Keywords: investor behavior; nominal prices; market capitalization; idiosyncratic volatility; institutional ownership; sentiment

JEL Classification: G11, G14