Penny Wise, Dollar Foolish: Buy–Sell Imbalances On and Around Round Numbers

What is it about?

Using a random sample of more than 100 million stock transactions, we find excess buying by liquidity demanders at all price points one penny below round numbers (.99), and excess selling by liquidity demanders at all price points one penny above round numbers (.01). These actions are not smart. Buying (selling) by liquidity demanders below (above) round numbers yield losses approaching $1 billion per year.

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Why is it important?

It is well known that round numbers are cognitive reference points and traders use them for anchoring. Most trades are at round numbers. This is the first paper which shows that most buying is a cent below a round number, and most selling is at a cent above a round number. It is also the first paper which estimates the cost of this behavioral bias. The paper was featured in the Financial Times on January 31, 2009.

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