WORKING PAPERS

Consistent with recent findings that investors perceive performance by price changes, cross-sectional return extrapolation comes entirely from capital gains. Stocks that do not pay dividends (capital-gain stocks) experience robust return extrapolation, while dividend-paying stocks do not. Using a stock’s dividend-paying status to proxy for exposure to return extrapolation, I test cross-sectional predictions of return extrapolation models. Consistent with return extrapolation models, momentum and long-term reversal are stronger among capital-gain stocks. The value premium, however, is similar for both groups, suggesting that while return extrapolation may help generate momentum and long-term reversal, its role is limited for the value premium.

Online Appendix

A firm’s investment responds to the stock valuations of other firms headquartered nearby. This response is stronger among financially constrained firms, is robust to controlling for the investment of other firms in the region, and is driven by the valuations of large firms. These findings are difficult to reconcile with existing theories that link investment opportunities to firm valuations, but instead suggest that a firm’s access to credit rises and falls with the valuations of other firms located nearby. Consistent with this explanation, financially constrained firms issue more debt and receive lower loan spreads when neighboring firms have higher valuations.

We provide evidence that purchase prices impact how investors behave towards extreme returns. Using a sample of individual investor trades and extreme return dates, we show that when a stock is trading farther from an investor's purchase price, the investor is more likely to trade in the direction of the stock's return. Consistent with relative overreaction, stocks trading farthest from their average purchase price experience the most extreme returns, which are then followed by greater subsequent reversals. A cross-sectional strategy motivated by these findings earns a monthly alpha of 1.02%.

WORKS IN PROGRESS

When Do Retail Investors Provide Liquidity? (with Hannes Mohrschladt)

Return Seasonalities: The Role of Institutional Investors (with Dongxu Li)