Disentangling Anomalies: Risk Versus Mispricing

Abstract

We examine the cross-section of returns from the perspective of a benchmark model that only includes systematic mispricing factors. In contrast to insight revealed by standard benchmark models, we recover robust positive risk-return relations for many cross-sectional risk, distress, and friction proxies. Our findings are consistent with systematic mispricing that primarily affects speculative stocks and predominantly results in overpricing, predicting lower returns. Hence, failing to control for exposure to systematic mispricing can bias tests of risk-return tradeoffs. Overall, our evidence suggests that a small shift in perspective generates a substantially different interpretation of the same data.

Keywords: low-risk anomalies, mispricing, sentiment, risk, distress, frictions

JEL Classification: G12, G14, D84