Information Uncertainties and Asset Pricing Puzzles: Risk or Mispricing?

Abstract

Prior research has documented the role of information uncertainty in the cross-sectional variation in stock returns. Miller (1977) hypothesizes that if information uncertainty is caused by differences of opinion, prices will reflect only the positive beliefs due to short-sale constraints. These anomalous stock price behaviors may result from mispricing. In contrast, Merton (1974) asserts that default risk is a function of the uncertainty in the asset value process. Information uncertainty may be subsumed by credit or default risk. We provide empirical evidence consistent with Merton’s (1974) default risk hypothesis and inconsistent with Miller’s (1977) mispricing hypothesis.

Keywords: Information uncertainty; Fundamental uncertainty; Valuation uncertainty

JEL Classification: G10; G12; G14