Abstract: A large number of stock characteristics have been found to predict the cross-section of returns. Return predictability can be driven by risk or mispricing, and the nature of most return predictors remains an open question. I use analysts’ earnings forecasts to determine if a return predictor is linked to mispricing. I find that at least 40% of return predictors from a dataset of 172 significant predictors are related to mispricing, including the momentum predictor from the Carhart four-factor and the profitability and investment predictors from the Fama–French five-factor model. I further study whether the mispricing predictors’ abnormal returns capture the divergence of prices from the fundamental value (build-up predictors) or their convergence back to the fundamental value (resolution predictors). Build-up predictors are less common than resolution predictors but do exist, implying that trading on certain return predictors can exacerbate rather than eliminate mispricing. Momentum is related both to the build-up and the resolution of mispricing.

With Axel Ockenfels and Martin Schmalz

Link coming soon

With Markus Dertwinkel-Kalt
International Economic Review, forthcomming