The Nominal Price Premium

Fisher College of Business Working Paper No. 2015-03-15

Charles A. Dice Center Working Paper No. 2015-15

47 Pages Posted: 20 Aug 2015 Last revised: 17 Dec 2016

See all articles by Justin Birru

Justin Birru

Ohio State University (OSU) - Department of Finance

Baolian Wang

University of Florida - Department of Finance, Insurance and Real Estate

Date Written: October 27, 2015

Abstract

Motivated by the evidence that investors tend to be overly optimistic about low-priced stocks, we examine how nominal price affects the cross section of stock returns. To circumvent the mechanical inverse relationship between price and expected return, we construct a novel way of examining the effect of nominal price on the cross section of stock returns. In the cross-section, a portfolio exploiting this strategy generates a value-weighted (equal-weighted) four-factor alpha of 85 (88) basis points per month, while raw price does not predict return robustly. Consistent with a mispricing-based explanation, the results are stronger for hard-to-arbitrage stocks and following high sentiment periods, and strategy returns are highly correlated with contemporaneous changes in sentiment. Using stock splits as an exogenous change in price level, we find that the post-split return dynamics mimic those predicted by our hypothesis. Evidence from earnings surprises and analyst price target forecasts confirms that beliefs are overly optimistic for low-priced stocks. Providing further evidence that the results reflect a belief-based rather than purely a preference-based channel, we find that the effect is distinct from other gambling related proxies that have been used in the past such as extreme returns, idiosyncratic volatility, and skewness.

Keywords: nominal price, behavioral finance, anomalies

JEL Classification: G02, G12, G14

Suggested Citation

Birru, Justin and Wang, Baolian, The Nominal Price Premium (October 27, 2015). Charles A. Dice Center Working Paper No. 2015-15. Available at SSRN: https://ssrn.com/abstract=2646775 or http://dx.doi.org/10.2139/ssrn.2646775

Justin Birru (Contact Author)

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

Baolian Wang

University of Florida - Department of Finance, Insurance and Real Estate ( email )

314 Stuzin Hall
Gainesville, FL 32611
United States

HOME PAGE: http://www.wangbaolian.com

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