Effect of Price Inefficiency on Idiosyncratic Risk and Stock Returns

54 Pages Posted: 3 Sep 2013 Last revised: 28 Dec 2013

See all articles by Nan Qin

Nan Qin

College of Business, Northern Illinois University

Date Written: November 27, 2013

Abstract

This paper finds that price inefficiency in individual stocks contributes to expected idiosyncratic volatility. If idiosyncratic risk is priced, greater price inefficiency could be associated with higher expected returns. Consistent with this hypothesis, this paper then finds a positive relation between price inefficiency and future stock returns. This return premium of price inefficiency is not explained by traditional risk factors, illiquidity, or transactions costs. It is also evidently different from the return bias related to Jensen’s inequality. This paper thus provides new insights about the determinants of expected stock returns, and new supporting evidence that idiosyncratic risk is priced.

Keywords: mispricing, idiosyncratic risk, stock return

JEL Classification: G11, G12, G14

Suggested Citation

Qin, Nan, Effect of Price Inefficiency on Idiosyncratic Risk and Stock Returns (November 27, 2013). Available at SSRN: https://ssrn.com/abstract=2319562 or http://dx.doi.org/10.2139/ssrn.2319562

Nan Qin (Contact Author)

College of Business, Northern Illinois University

1425 W. Lincoln Hwy.
DEKALB, IL 60115
United States

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