Mispricing Revealed Through the Information Ratio

Abstract

We document that the Information ratio identifies overpriced and underpriced stocks. The contrarian strategies based on 60 information ratios generate an average monthly Carhart alpha (with a t-stat)
of 0.63% (4.5). The performance is not due to past returns, volatility, various characteristics, market
microstructures, and investors’ lottery-related preferences. Factors from ten prominent factor models, including the mispricing factors of Stambaugh and Yuan (2017), do not explain the results. Our analysis of the timing and evolution of the identified mispricing and its relation with firm fundamentals suggests that the conditional realized information ratio is a proxy for the stock-level sentiment

Keywords: Mispricing, Sentiment, Cross-Section of Stock Returns, Realized Sharpe Ratio, Information Ratio, Momentum, Reversal, Idiosyncratic Volatility

JEL Classification: G12