NBER Working Paper No. 21533
A four-factor model with two "mispricing" factors, in addition to market and size factors, accommodates a large set of anomalies better than notable four- and five-factor alternative models. Moreover, our size factor reveals a small-firm premium nearly twice usual estimates. The mispricing factors aggregate information across 11 prominent anomalies by averaging rankings within two clusters exhibiting the greatest co-movement in long-short returns. Investor sentiment predicts the mispricing factors, especially their short legs, consistent with a mispricing interpretation and the asymmetry in ease of buying versus shorting. Replacing book-to-market with a single composite mispricing factor produces a better-performing three-factor model.
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Document Object Identifier (DOI): 10.3386/w21533
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