IDEAS home Printed from https://ideas.repec.org/p/nbr/nberwo/7615.html
   My bibliography  Save this paper

Covariance Risk, Mispricing, and the Cross Section of Security Returns

Author

Listed:
  • Kent D. Daniel
  • David Hirshleifer
  • Avanidhar Subrahmanyam

Abstract

This paper offers a multisecurity model in which prices reflect both covariance risk and misperceptions of firms' prospects, and in which arbitrageurs trade to profit from mispricing. We derive a pricing relationship in which expected returns are linearly related to both risk and mispricing variables. The model thereby implies a multivariate relation between expected return, beta, and variables that proxy for mispricing of idiosyncratic components of value tends to be arbitraged away but systematic mispricing is not. The theory is consistent with several empirical findings regarding the cross-section of equity returns, including: the observed ability of fundamental/price ratios to forecast aggregate and cross-sectional returns, and of market value but not non-market size measures to forecast returns cross-sectionally; and the ability in some studies of fundamental/price ratios and market value to dominate traditional measures of security risk. The model also offers several untested empirical implications for the cross-section of expected returns and for the relation of volume to subsequent volatility.

Suggested Citation

  • Kent D. Daniel & David Hirshleifer & Avanidhar Subrahmanyam, 2000. "Covariance Risk, Mispricing, and the Cross Section of Security Returns," NBER Working Papers 7615, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:7615
    Note: AP
    as

    Download full text from publisher

    File URL: http://www.nber.org/papers/w7615.pdf
    Download Restriction: no

    References listed on IDEAS

    as
    1. Gervais, Simon & Odean, Terrance, 2001. "Learning to be Overconfident," Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 1-27.
    2. Shlomo Benartzi & Richard H. Thaler, 1995. "Myopic Loss Aversion and the Equity Premium Puzzle," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 73-92.
    3. Barberis, Nicholas & Shleifer, Andrei & Vishny, Robert, 1998. "A model of investor sentiment," Journal of Financial Economics, Elsevier, vol. 49(3), pages 307-343, September.
    4. Anat R. Admati, Paul Pfleiderer, 1988. "A Theory of Intraday Patterns: Volume and Price Variability," Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 3-40.
    5. repec:hrv:faseco:30747159 is not listed on IDEAS
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Hugh Kelley & Tom Evans, 2010. "Measuring the Impact of Behavioral Traders in the Market for Closed-end Country Funds from 2002 to 2009," Chapters,in: Handbook of Behavioral Finance, chapter 16 Edward Elgar Publishing.
    2. Guerdjikova, Ani, 2006. "Portfolio Choice and Asset Prices in an Economy Populated by Case-Based Decision Makers," Working Papers 06-13, Cornell University, Center for Analytic Economics.
    3. Yannick Malevergne & Pedro Santa-Clara & Didier Sornette, 2009. "Professor Zipf goes to Wall Street," NBER Working Papers 15295, National Bureau of Economic Research, Inc.

    More about this item

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:7615. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (). General contact details of provider: http://edirc.repec.org/data/nberrus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.