Split-Adjusted Stock Price and the Cross-Section of US Stock Returns

Abstract

The price of a security potentially contains incremental information regarding its (unobservable) required rate of return. We construct a simple theoretical model to derive the expected rate of return conditional on an observed split-adjusted stock price using Bayesian updating. The model suggests that expected return should be negatively related to the logarithm of split-adjusted price in the cross-section. This provides a theoretical explanation of the split-adjusted price anomaly first documented by Brown and Pfeiffer (2007). There is strong empirical evidence linking split-adjusted price with subsequent realised US stock returns. Among more than 100 anomaly hedge portfolios constructed using the same US stock return data and portfolio construction methods, the split-adjusted price decile hedge portfolio generates the highest value-weighted mean return (151 bp/month, t-statistic 7.12) and among the highest time-series alphas under several benchmark models. We argue that as one of the largest and seemingly most robust anomalies yet documented the split-adjusted price anomaly deserves more attention than it has received so far. ∗Corresponding author. E-mail: p.geertsema@auckland.ac.nz. Department of Accounting and Finance, University of Auckland Business School, Auckland, New Zealand. †E-mail: helen.lu@auckland.ac.nz. Department of Accounting and Finance, University of Auckland Business School, Auckland, New Zealand.