TY  - JOUR
AU  - Daniel,Kent D.
AU  - Hirshleifer,David
AU  - Subrahmanyam,Avanidhar
TI  - Covariance Risk, Mispricing, and the Cross Section of Security Returns
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 7615
PY  - 2000
Y2  - March 2000
UR  - http://www.nber.org/papers/w7615
L1  - http://www.nber.org/papers/w7615.pdf
N1  - Author contact info:
Kent D. Daniel
Columbia Business School
3022 Broadway, Uris Hall 709
New York, NY 10027
Tel: 212-854-4579
E-Mail: kd2371@columbia.edu

David Hirshleifer
Merage School of Business
University of California, Irvine
Irvine, CA  92697
Tel: 949-824-9955
E-Mail: david.h@uci.edu

Avanidhar Subrahmanyam
Anderson School of Management
UCLA
110 Westwood Plaza  C402
Los Angeles, CA 90095
Tel: 310-825-5355
E-Mail: subra@anderson.ucla.edu
AB  - 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.
ER  -