Abstract
This paper examines the characteristics and pricing behavior of penny stocks comprehensively. We find that penny stocks are characterized with high return, high beta, small size, high book-to-market ratio, high idiosyncratic volatility, and poor past performance. The liquidity costs of penny stocks are significantly higher than high priced stocks. Penny stocks as a whole do not earn abnormal profits after controlling for various risk factors, and their seemingly high returns are driven by the liquidity risk. However, the trading strategies that buying small or value penny stocks and short selling large or growth penny stocks do make considerable abnormal profits both over short- and long-term holding periods even after all of the risk factors are controlled for.
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