Mispricing and Uncertainty in International Markets
45 Pages Posted: 16 Feb 2021 Last revised: 10 Mar 2021
Date Written: November 2, 2020
We develop Residual MisPricing (RMP), an index capturing mispricing relative to a linear benchmark asset pricing model, from the structure imposed by no-arbitrage. RMP is fully conditional and depends only on the returns of basic assets. Return data for several economies reveal that RMP is countercyclical and related to financial uncertainty. RMP further shows a strong positive relation to conditional international equity and currency risk premia, as well as a close link to market-wide funding liquidity shocks. The relations we document hold in particular out-of-sample. Our evidence points to new record highs for RMP during the COVID-19 era, similar to its behavior in the 2008 financial crisis.
Keywords: stochastic discount factor, residual mispricing, financial uncertainty, exchange rates, machine learning.
JEL Classification: G11, G12, G15
Suggested Citation: Suggested Citation