Salience and Neglected Risk

A long-short strategy that buys stocks having salient features and sells those that do not generates a monthly excess return of 48 basis points that is not explained by prominent factors. The portfolio generates positive returns in 31 out of 42 years in the sample period. The pattern is consistent with the salience theory of asset pricing in which investors overweight upside potential associated with salient features, but neglect risk associated with non-salient features. We show that the premium associated with stocks having salient features goes away once a stock loses its salient features. Those that maintain their salient features do not exhibit
negative excess returns compared with similar stocks. These results suggest the neglect of crash risk leads to the observed lower return of stocks with salient features. The results of this paper provide supporting evidence that salience plays an important role in inducing investors to neglect risk.