Putting the Price in Asset Pricing
68 Pages Posted: 28 Dec 2019 Last revised: 6 Jan 2021
Date Written: December 28, 2019
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, E[MR^e]=0, used to study returns. Our empirical test reveals that the CAPM describes the cross-section of prices better than it describes expected short-horizon returns. Despite the improvement, significant mispricing remains. An interaction of book-to-market and quality provides 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: Suggested Citation