Commonality in Misvaluation, Equity Financing, and the Cross Section of Stock Returns

Abstract:     
Behavioral theories suggest that investor misperceptions and market mispricing will be correlated across firms. This paper uses equity financing to identify comovement in returns and commonality in misvaluation. A zero-investment portfolio (UMO, Undervalued Minus Overvalued) built from repurchase and new issue stocks captures excess comovement in general stock returns relative to a set of multi-factor models. Adding UMO to the 3-factors makes the alphas insignificant for portfolios with extreme size and book-to-market, or based on M&A, convertible bond issuance, and dividend initiation, resumption, and omission. The loadings on UMO incrementally predict the cross-section of returns on portfolios as well as individual stocks. Further evidence is consistent with the UMO loading proxying for the common component of a stock's misvaluation.

Keywords: Comovement, equity financing, new issue, repurchase, systematic mispricing, return predictability

JEL Classifications: G12, G14

Working Paper Series