Stock Price Clustering and Discreteness: The "Compass Rose" and Predictability

TL;DR

This paper examines the 'compass rose' patterns in stock return phase portraits, questioning whether they are solely due to price clustering and discreteness, and explores their implications for stock return predictability.

Contribution

It challenges the assumption that compass rose patterns are only caused by price discreteness, suggesting they may contain additional information relevant for predictability.

Findings

Compass rose patterns are not solely due to price clustering.

These patterns may have implications for stock return predictability.

Price discreteness influences but does not fully explain the patterns.

Abstract

In this letter we investigate the information provided by the "compass rose" (Crack, T.F. and Ledoit, O. (1996), Journal of Finance, 51(2), pg. 751-762) patterns revealed in phase portraits of daily stock returns. It has been initially suggested that the compass rose is just a manifestation of price clustering and discreteness and the tick size, factors that can affect the unbiasedness of an array of statistical tests based on stock returns. We show that this may not entirely be the case.