Pricing Deviation, Misvaluation Comovement, and Macroeconomic Conditions

Abstract

We measure individual stocks' misvaluation based on their firm-specific deviations from predicted intrinsic values. The misvaluation measure exhibits association with stocks' valuation uncertainty and arbitrage difficulty, and has significant power to forecast stock returns incremental to size, book-to-market ratio, momentum, and various return anomalies. Based on the misvaluation measure, we form a misvaluation factor and find that stocks' return covariances with this factor strongly predict the cross-section of returns even after the control of stocks' sensitivities to other return factors. We further show that the misvaluation factor and market-wide misvaluation waves predict future macroeconomic conditions, which provides further insights into the pricing of systematic misvaluation in the market.

Keywords: Misvaluation, comovement, factor models, market efficiency, macroeconomic conditions

JEL Classification: G12, G14