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The Mispricing Return Premium
Michael J. Brennan University of California, Los Angeles - Finance Area Ashley Wang University of California, Irvine - Paul Merage School of Business Feburary 15, 2009 Abstract: We show that, when stock prices are subject to stochastic mispricing errors, as a result of Jensen's inequality, expected rates of return may depend not only on the fundamental risk that is captured by a standard asset pricing model, but also on the type and degree of asset mispricing, even when the mispricing is zero on average. Empirically, the mispricing induced return premium, either estimated using a Kalman filter or proxied by the volatility and variance ratio of residual returns, is shown to be significantly associated with realized risk adjusted returns.
Keywords: Jensen's Inequality, Asset Pricing Test JEL Classifications: G10, G12 Working Paper SeriesDate posted: August 19, 2008 ; Last revised: February 19, 2009Suggested CitationContact Information
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