Does risk or mispricing explain the cross-section of stock prices?
By: Randolph B. Cohen, Christopher Polk, Tuomo Vuolteenaho
Contributors: Polk, Christopher; Vuolteenaho, Tuomo; Harvard Business School. Division of Research
Edition: Rev.].
Series: Working paper / Division of Research, Harvard Business School -- 03-107; Working paper (Harvard Business School. Division of Research) -- 03-107
Publisher: Division of Research, Harvard Business School
Published: 2003
Place of publication: Boston]
Language: eng
Number of pages: 37
Description: Most previous research evaluates market efficiency and asset pricing models using average abnormal trading profits on dynamic trading strategies. We measure the ability of the capital asset pricing model (CAPM) and the efficient-market hypothesis to explain the level of stock prices. First, we find that cash-flow beta (measured by regressing firms' earnings on the market's earnings) explain the prices of value and growth stocks well, with a plausible premium. Second, we use a present-value model to decompose the cross-sectional variance of firms' price-to-book ratios into two components due to risk-adjusted fundamental value and mispricing. When we allow the discount rates to vary as predicted by the CAPM, the variance share of mispricing is negligible.
Notes: Revision of: The value spread. Division of Research, Harvard Business School, c2001. Series no. 01-084.

"Some of the ideas in this paper were first presented as Section V of the paper titled: "The value spread" at the NBER 2000 Summer Institute."

"First draft: 12/31/2001. This draft: 7/10/2002."

Includes bibliographical references.