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Analyst Disagreement, Mispricing, and Liquidity

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  • RONNIE SADKA
  • ANNA SCHERBINA
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    Abstract

    This paper documents a close link between mispricing and liquidity by investigating stocks with high analyst disagreement. Previous research finds that these stocks tend to be overpriced, but that prices correct downwards as uncertainty about earnings is resolved. Our analysis suggests that one reason mispricing has persisted through the years is that analyst disagreement coincides with high trading costs. We also show that in the cross-section, the less liquid stocks tend to be more severely overpriced. Additionally, increases in aggregate market liquidity accelerate the convergence of prices to fundamentals. As a result, returns of the initially overpriced stocks are negatively correlated with the time series of innovations in aggregate market liquidity. Copyright 2007 by The American Finance Association.

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    File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1540-6261.2007.01278.x
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    Bibliographic Info

    Article provided by American Finance Association in its journal The Journal of Finance.

    Volume (Year): 62 (2007)
    Issue (Month): 5 (October)
    Pages: 2367-2403

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    Handle: RePEc:bla:jfinan:v:62:y:2007:i:5:p:2367-2403

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    Cited by:
    1. Da, Zhi & Schaumburg, Ernst, 2011. "Relative valuation and analyst target price forecasts," Journal of Financial Markets, Elsevier, vol. 14(1), pages 161-192, February.
    2. Avramov, Doron & Chordia, Tarun & Jostova, Gergana & Philipov, Alexander, 2009. "Dispersion in analysts' earnings forecasts and credit rating," Journal of Financial Economics, Elsevier, vol. 91(1), pages 83-101, January.
    3. Subrahmanyam, Avanidhar, 2009. "The implications of liquidity and order flows for neoclassical finance," Pacific-Basin Finance Journal, Elsevier, vol. 17(5), pages 527-532, November.
    4. Loh, Roger, 2008. "Investor Attention and the Underreaction to Stock Recommendations," Working Paper Series 2008-2, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    5. Huang, Alan Guoming, 2009. "The cross section of cashflow volatility and expected stock returns," Journal of Empirical Finance, Elsevier, vol. 16(3), pages 409-429, June.
    6. Fernando Lefort & Fernando Diaz, 2013. "Macroeconomic Stability, Financial Risks and Market Eciency: Evidence for a Small and Open Economy," Working Papers 45, Facultad de Economía y Empresa, Universidad Diego Portales.
    7. Serrano-Padial, Ricardo, 2012. "Naive traders and mispricing in prediction markets," Journal of Economic Theory, Elsevier, vol. 147(5), pages 1882-1912.
    8. Raphael Flepp & Stephan Nüesch & Egon Franck, 2013. " Liquidity, Market Efficiency and the Influence of Noise Traders: Quasi-Experimental Evidence from the Betting Industry," Working Papers 341, University of Zurich, Department of Business Administration (IBW).
    9. Kamara, Avraham & Lou, Xiaoxia & Sadka, Ronnie, 2008. "The divergence of liquidity commonality in the cross-section of stocks," Journal of Financial Economics, Elsevier, vol. 89(3), pages 444-466, September.

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