Style Migration and the Cross-Section of Stock Returns

Stocks experiencing sharp changes in their style characteristics present unique opportunities to examine how investors view style information in making their portfolio allocation decisions. We examine the average returns of such stocks-which we call "style migrants"-and the covariation of the returns of style migrants with their new style cohort stocks to provide new insight into the way investors use equity style information. Our results indicate that investors strongly judge a stock by its style. Specifically, we find that stocks experiencing large levels of variability in their book-to-market and momentum characteristics during the prior three years significantly outperform, during the following year, other stocks with more style stability. In addition, these high style risk stocks covary much more with their new style cohorts than do low style risk stocks that have also moved into the same new style category, consistent with investors overreacting to style shifts of high style risk stocks, while exhibiting a "style memory" effect for low style-risk stocks. In further tests, we find some evidence that high style risk stocks exhibit style return reversals, while low style risk stocks exhibit style return continuations. Overall, our paper provides new evidence about investor behavior by demonstrating that some investors appear to overweight style information when allocating their portfolios, especially for certain high style-risk stocks.