The Excess Returns of 'Quality' Stocks: A Behavioral Anomaly
11 Pages Posted: 18 Jan 2016 Last revised: 27 Nov 2017
Date Written: January 15, 2016
This note investigates the causes of the quality anomaly, which is one of the strongest and most scalable anomalies in equity markets. We explore two potential explanations. The "risk view", whereby investing in high quality firms is somehow riskier, so that the higher returns of a quality portfolio are a compensation for risk exposure. This view is consistent with the Efficient Market Hypothesis. The other view is the "behavioral view", which states that some investors persistently underestimate the true value of high quality firms. We find no evidence in favor of the "risk view": The returns from investing in quality firms are abnormally high on a risk-adjusted basis, and are not prone to crashes. We provide novel evidence in favor of the "behavioral view": In their forecasts of future prices, and while being overall overoptimistic, analysts systematically underestimate the future return of high quality firms, compared to low quality firms.
Keywords: Quality anomaly, financial analysts misplaced focus, behavioral biases
JEL Classification: G00, G14, G20
Suggested Citation: Suggested Citation