Range-Based Expectations

I propose and document empirically that investors form “range-based” expectations – expectations that are influenced by an asset’s past trading range – and that these beliefs affect trading behavior and asset prices. I find that, if an asset’s price is high (low) relative to its 52- week trading range, investors erroneously believe that the asset’s future return distribution is negatively (positively) skewed. Consistent with these beliefs, less sophisticated investors trade options in a way that decreases their exposure to underlying stocks that have a high price relative to their 52-week range; moreover, individual investors are more likely to sell and not buy such stocks. Also consistent with these beliefs, stocks with a high (low) price relative to their past trading range earn high (low) subsequent returns, on average.