Salience Theory and the Cross-Section of Stock Returns: International and Further Evidence
60 Pages Posted: 17 Dec 2020 Last revised: 6 Feb 2021
Date Written: December 17, 2020
The salience theory perspective on asset prices implies that investors overvalue stocks with salient upsides while undervaluing firms with salient downsides. The resulting mispricing is subsequently reverted—producing a predictable pattern in the cross-section of returns. This study is the first to perform an international examination of this phenomenon. We demonstrate that the salience effect prevails globally, and it is augmented by country-specific illiquidity. However, it is priced only among microcaps—accounting for a minuscule fraction of total market capitalization. Additionally, the premium is primarily realized following severe down markets and volatility spikes. Outside of these extreme market segments and states, the salience anomaly does not exist.
Keywords: salience theory, probability weighting, microcaps, asset pricing, firm size, return predictability, equity anomalies, international markets, replication
JEL Classification: D03, G11, G12, G14
Suggested Citation: Suggested Citation