Abstract
Experimental evidence shows that recent observations have a stronger impact on the formation of beliefs than observations from the more distant past. Thus, if investors judge upon a stock's attractiveness based on historical return data, they presumably overweight the most recent returns. Based on this simple idea, we propose a new empirical measure of recency adjustment that reflects the ordering of previous returns. Based on the conjectured behavioral mechanisms, recency adjustment should be systematically related to stock mispricing. We use US stock market data from 1926 to 2016 to support this hypothesis empirically and show that recency adjustment is a strong predictor for the cross-section of subsequent returns.
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