Effect of free float on stock performance with divergence of opinion hypothesis

Abstract

This research investigates the effect of free float on stock performance under an assumption that investors have divergence of opinion. The objective of this study is to provide an empirical evidence of free float effect in a different viewpoint and to answer whether effect of free float on stock performance should be considered together with the effect of opinion divergence. This research examines both Thai and U.S. markets during 2000 to 2014. The author uses multiple proxies of investors’ degree of opinion divergence, namely dispersion of analysts’ earnings forecasts and idiosyncratic volatility, to ensure the robustness of the results. The empirical results reveal that investors’ degree of opinion divergence affects the sensitivity of stock price to free float. The more opinions diverge, the larger the negative effect of free float on stock price. This evidence is consistent with the prediction of this research. The results also display a negative relationship between free float and stock future volatility, which is, again, consistent with the prediction. However, when the author conducts tests on free float and future return of stocks, the results show that free float is negatively related to stock future return, which appears to be against the research’s prediction. Nonetheless, this negative relation is in line with the view that that free float is a proxy for stock liquidity. The increase of free float implies the increase of asset’s liquidity and hence the decrease in liquidity premium. If this type of risk reflects in a stock price, such stocks should yield lower future returns. The author finds the supportive evidence to this argument and it reveals that the results of relationship between free float and stock future return might be dominated by the liquidity effect. As a result, we can reconcile the conflicting results and conclude that the predicted effect of free float holds true. The main implication is that investors should consider the free float effect to the stock price along with the opinion divergence effect. Moreover, stocks with high degree of opinion divergence should be prudently monitored by regulators because such stocks could exhibit an excessively high volatility if there is a change of free float.