Risk or Mispricing? From the Mouths of Professionals

Abstract:     
Most tests of asset pricing models rely on realized returns as a proxy for expected returns, and cannot determine whether security characteristics are associated with returns because they affect risk or because they reflect mispricing. This paper avoids these problems by conducting two experiments in which we directly elicit how Beta, Market-to-Book ratios and firm size affect the returns expected by Wall Street professionals, and how those factors affect perceived risk and mispricing. Consistent with traditional asset pricing models, professionals expect firms with higher Betas to be riskier investments and generate higher returns. Consistent with behavioral models, professionals expect firms with higher Market-to-Book ratios to be over-priced (and riskier). Professionals expect large firms to be less risky, but do not view firm size to be a sign of mispricing.

Number of Pages in PDF File: 37

working papers series