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Nominal price illusion

Justin Birru and Baolian Wang

Journal of Financial Economics, 2016, vol. 119, issue 3, 578-598

Abstract: We explore the psychology of stock price levels and provide evidence that investors suffer from a nominal price illusion in which they overestimate the room to grow for low-priced stocks relative to high-priced stocks. While it has become increasingly clear that nominal price levels influence investor behavior, why prices matter to investors is a question that as of yet has gone unanswered. We find widespread evidence that investors systematically overestimate the skewness of low-priced stocks. In the broad cross-section of stocks, we find that investors substantially overweight the importance of price when forming skewness expectations. Asset pricing implications of our findings are borne out in the options market. A zero-cost option portfolio strategy that exploits investor overestimation of skewness for low-priced stocks generates significant abnormal returns. Finally, investor expectations of future skewness increase drastically on days that a stock undergoes a split to a lower nominal price. Empirically, however, future physical skewness decreases following splits.

Keywords: Nominal price; Skewness; Stock splits; Options; Behavioral finance (search for similar items in EconPapers)
JEL-codes: G02 G11 G12 G13 G14 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (50)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:119:y:2016:i:3:p:578-598

DOI: 10.1016/j.jfineco.2016.01.027

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