Asset Pricing with Price Levels

74 Pages Posted: 28 Dec 2019 Last revised: 8 Sep 2020

See all articles by Thummim Cho

Thummim Cho

London School of Economics & Political Science (LSE) - Department of Finance

Christopher Polk

London School of Economics

Date Written: November 18, 2019

Abstract

We propose a novel way to study asset prices based on price distortions rather than abnormal returns. We derive the correct identity linking current mispricing to subsequent returns, generating a price-level analogue to the fundamental asset pricing equation used to study returns. Our GMM test reveals that the CAPM describes the cross-section of prices noticeably better than it describes expected short horizon returns. Despite the improvement, significant mispricing remains. We show that book-to-market, quality, and size provide a parsimonious model of CAPM mispricing that both long-term buy-and-hold investors and researchers disciplining models from the price perspective should prioritize.

Keywords: price level, long-horizon returns, mispricing metric, stochastic discount factor, CAPM

JEL Classification: G12, G14, G32

Suggested Citation

Cho, Thummim and Polk, Christopher, Asset Pricing with Price Levels (November 18, 2019). Available at SSRN: https://ssrn.com/abstract=3499681 or http://dx.doi.org/10.2139/ssrn.3499681

Thummim Cho (Contact Author)

London School of Economics & Political Science (LSE) - Department of Finance ( email )

United Kingdom

Christopher Polk

London School of Economics ( email )

United Kingdom

HOME PAGE: http://personal.lse.ac.uk/polk/

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