Pricing Without Mispricing
52 Pages Posted: 8 Jul 2021 Last revised: 6 May 2022
Date Written: February 8, 2022
We investigate whether various asset pricing models could hold in an efficient market. Assuming decade-old information should be priced correctly, we test whether a model assigns zero alpha to investment strategies that use only such information. The CAPM passes this test, but prominent multifactor models do not. Multifactor betas may help capture expected returns on mispriced stocks, but persistence in those betas distorts the stocks' implied expected returns after prices correct. Such effects are strongest in large-cap stocks, whose multifactor betas are the most persistent. Hence, prominent multifactor models distort expected returns, absent mispricing, for the largest, most liquid stocks.
Keywords: asset pricing, mispricing, market efficiency
JEL Classification: G12,G14,G40
Suggested Citation: Suggested Citation