Analyst Disagreement, Mispricing and Liquidity

Abstract:     
This paper documents a close link between mispricing and liquidity by investigating stocks with high analyst disagreement. Previous research finds that these stocks tend to be overpriced, but that prices correct downwards as uncertainty about earnings is resolved. Our analysis suggests that one reason mispricing has persisted through the years is that analyst disagreement coincides with high trading costs. We also show that in the cross-section, the less liquid stocks tend to be more severely overpriced. Additionally, increases in aggregate market liquidity accelerate the convergence of prices to fundamentals. As a result, returns of the initially overpriced stocks are negatively correlated with the time series of innovations in aggregate market liquidity.

Number of Pages in PDF File: 42

Keywords: Analyst disagreement, mispricing, liquidity, Kyle lambda, limits of arbitrage

JEL Classification: G14, G29, G10

Accepted Paper Series