Random Pricing Errors and Systematic Returns: Is There a Frequentist Flaw in Market Prices?
35 Pages Posted: 11 Jun 2015 Last revised: 27 Jun 2018
Date Written: March 16, 2017
This paper examines the consequences of widespread and significant pricing errors. If market valuations differ from intrinsic value but are unbiased estimates of it, certain systematic mispricing patterns will arise. To remove these phenomena, market prices need to adjust away from unbiased estimates of firm value. Using Bayesian concepts, this paper derives the properties of the resulting adjusted prices. Whether this outcome is achieved, however, is unclear. A number of well-known empirical phenomena are in line with the view that there are material pricing errors and historically, price adjustments have been incomplete.
Keywords: Pricing Errors, Factor Returns
JEL Classification: G1, G12, G14
Suggested Citation: Suggested Citation