Abstract
Empirical evidence shows that stock price magnitude influences portfolio choices and/or future returns, an observation at odds with standard finance theory. Authors most often refer to stock characteristics such as high variance and positive skewness of returns to justify this result. In this paper, we show that price magnitude matters independently of stock characteristics. Using experimental markets, which allow us to neutralize the effect of asset characteristics, we find that subjects process "small"and "large"prices differently. Small price markets exhibit greater mispricing than large price markets. Our findings cannot be explained by stock characteristics (lottery-like features or perceived skewness), which indicates that the price magnitude in itself has a direct impact on how the subjects' brain perceives the distribution of future returns. Though at odds with standard finance theory, our findings are consistent with: (1) evidence in neuropsychology on the use of different mental scales for small and large numbers, and (2) empirical results in the finance literature.