Price Level

This chapter evaluates the stock price level at the end of previous month as the return predictor. The simple question we ask here is that if we use the last month’s stock price level to explain this month’s stock return, can we obtain statistically and economically significant results? Stock prices are generally considered as complex return predictors; however, firms have the opportunity to choose a level for their stock prices.1 In the market microstructure literature, share price has been considered as a proxy for market liquidity. The stock split literature also examines this choice if it has any meaning other than maintaining a desired share price, such as signaling private information. Fama et al. (1969) provides evidence of superior earnings and dividends by splitting, and report in favor of the signaling hypothesis.2 Fernando, Krishnamurthy, and Spindt (1999) highlight that the economic significance of price level appears to be driven by the preferences of retail and institutional investors and this is in fact surprising since it conflicts with the expected utility theory stating that economic agents should be indifferent to various representations of the same choice problem.3