A Financing-Based Misvaluation Factor and the Cross Section of Expected Returns

Hirshleifer, David A.; Jiang, Danling

A Financing-Based Misvaluation Factor and the Cross Section of Expected Returns

Review of Financial Studies, Vol. 23, No. 9, pp. 3401-3436, 2010

AFA 2008 New Orleans Meetings Paper

WFA 2009 San Diego Meetings Paper

59 Pages Posted: 20 Mar 2007 Last revised: 22 Jun 2011

See all articles by David A. Hirshleifer

David A. Hirshleifer

University of California, Irvine - Paul Merage School of Business; NBER

Danling Jiang

College of Business, Stony Brook University

Date Written: February 10, 2010

Abstract

Behavioral theories suggest that investor misperceptions and market mispricing will be correlated across firms. We use equity and debt financing to identify common misvaluation across firms. A zero-investment portfolio (UMO, Undervalued Minus Overvalued) built from repurchase and new issue firms captures comovement in returns beyond that in some standard multifactor models, and substantially improves the Sharpe ratio of the tangency portfolio. Loadings on UMO incrementally predict the cross-section of returns on both portfolios and individual stocks, even among firms not recently involved in external financing activities. Further evidence suggests that UMO loadings proxy for the common component of a stock's misvaluation.

Keywords: Misvaluation, financing, new issues, repurchase, factor models, market efficiency, behavioral finance

JEL Classification: G12, G14

Suggested Citation: Suggested Citation

Hirshleifer, David A. and Jiang, Danling, A Financing-Based Misvaluation Factor and the Cross Section of Expected Returns (February 10, 2010). Review of Financial Studies, Vol. 23, No. 9, pp. 3401-3436, 2010 ; AFA 2008 New Orleans Meetings Paper; WFA 2009 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=972695