Salience Theory and Stock Prices: Empirical Evidence

Journal of Financial Economics, Forthcoming

2017 SFS Cavalcade Paper

70 Pages Posted: 21 Dec 2016 Last revised: 20 Apr 2020

See all articles by Mathijs Cosemans

Mathijs Cosemans

Erasmus University - Rotterdam School of Management

Rik Frehen

Tilburg University - Department of Finance

Date Written: March 2, 2020

Abstract

We present evidence on the asset pricing implications of salience theory. In our model, investors overweight salient past returns when forming expectations about future returns. Consequently, investors are attracted to stocks with salient upsides, which are overvalued and earn low subsequent returns. Conversely, stocks with salient downsides are undervalued and yield high future returns. We find empirical support for these predictions in the cross section of U.S. stocks. The salience effect is stronger among stocks with greater limits to arbitrage and during high-sentiment periods. Our results are not explained by common risk factors, return reversals, lottery demand, and attention-grabbing news events.

Keywords: salience theory, probability weighting, asset pricing, return predictability

JEL Classification: D03, G11, G12, G14

Suggested Citation

Cosemans, Mathijs and Frehen, Rik, Salience Theory and Stock Prices: Empirical Evidence (March 2, 2020). Journal of Financial Economics, Forthcoming, 2017 SFS Cavalcade Paper, Available at SSRN: https://ssrn.com/abstract=2887956 or http://dx.doi.org/10.2139/ssrn.2887956

Mathijs Cosemans (Contact Author)

Erasmus University - Rotterdam School of Management ( email )

Burgemeester Oudlaan 50
Rotterdam
Netherlands
+31104082371 (Phone)
+31104089017 (Fax)

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

Rik Frehen

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, DC Noord-Brabant 5000 LE
Netherlands

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