Salience-driven mispricing in retail-dominated markets: evidence from Korea

Abstract

This study examines whether salience theory explains stock returns in the Korean market from 2005 to 2024. We find a robust negative relationship between the salience of past returns (ST) and future stock returns. A long-short portfolio sorting on ST generates a significant four-factor alpha of −1.50% per month (t-stat = −5.91). We show that the effect is almost entirely driven by the trading of individual investors; the ST effect is pronounced in stocks heavily purchased by retail investors but is absent in stocks favored by institutions. Also, the ST-return relation is significantly stronger during periods of market-wide short-sale bans and for stocks with high idiosyncratic volatility. Finally, this relation is pronounced under low sentiment or high uncertainty states. Our results extend the salience-based asset pricing literature beyond developed markets and suggest that behavioral biases may be amplified in emerging market contexts.