Covariance Risk, Mispricing, and the Cross Section of Security Returns

Ohio State University Working Paper No. 2000-6

51 Pages Posted: 29 Dec 2000

See all articles by Kent D. Daniel

Kent D. Daniel

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

David A. Hirshleifer

University of California, Irvine - Paul Merage School of Business; NBER

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area; Institute of Global Finance, UNSW Business School; Financial Research Network (FIRN)

Multiple version iconThere are 2 versions of this paper

Date Written: July 2000

Abstract

This paper offers a model in which asset rices reflect both covariance risk and misperceptions of firms' prospects, and in which arbitrageurs trade against mispricing. In equilibrium, expected returns are linearly related to both risk and mispricing measures (e.g., fundamental/price ratios). With many securities, mispricing of idiosyncratic value components diminishes but systematic mispricing does not. The theory offers untested empirical implications about volume, volatility, fundamental/price ratios, and mean returns, and is consistent with several empirical findings. These include the ability of fundamental/price ratios and market value to forecast returns, and the domination of beta by these variables in some studies.

JEL Classification: G12,G14,G32,G35,D82

Suggested Citation

Daniel, Kent D. and Hirshleifer, David A. and Subrahmanyam, Avanidhar, Covariance Risk, Mispricing, and the Cross Section of Security Returns (July 2000). Ohio State University Working Paper No. 2000-6. Available at SSRN: https://ssrn.com/abstract=238339 or http://dx.doi.org/10.2139/ssrn.238339

Kent D. Daniel

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States
212-854-4679 (Phone)
212-854-4679 (Fax)

HOME PAGE: http://kentdaniel.net/

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

David A. Hirshleifer (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

Irvine, CA California 92697-3125
United States

HOME PAGE: http://sites.uci.edu/dhirshle/

NBER ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-5355 (Phone)
310-206-5455 (Fax)

Institute of Global Finance, UNSW Business School

Sydney, NSW 2052
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

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