The change in salience and the cross-section of stock returns: Empirical evidence from China A-shares

This study explores the relationship between stocks' change in salience (CS) and the cross-section of stock returns. We find that the change in salience can negatively predict future stock returns. Investors, attracted by salient attributes of choices, overestimate prominent rising trends in stock historical return performance and extrapolate, leading stocks with prominent rising trends to be overpriced and earning lower subsequent returns. In terms of potential mechanisms, we find that costly arbitrage and lottery preference are two underlying mechanisms behind the mispricing of CS. The CS effect is more pronounced among stocks with greater costly arbitrage and greater lottery preference. Moreover, both institutional and individual investors are shown to generate distortions of expectations induced by salient thinking. Our findings are robust after considering common risk factors, shell contamination, short-term reversals, the prospect theory, and investor attention.