Nominal price illusion

Recent work finds that nominal prices influence investor behavior. Why prices matter to investors, however, is a question that is as of yet unanswered. We 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. Investor expectations of future skewness increase drastically on days that a stock undergoes a split to a lower nominal price. However, in practice future physical skewness decreases. In the cross-section of stocks, we find that investors overweight the importance of price in their skewness expectations. Asset pricing implications of our findings are borne out in the options market. A zero-cost option portfolio strategy that exploits skewness overestimation for low-priced stocks relative to high-priced stocks earns economically and statistically significant returns