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.
We are grateful for comments from Lu Zhang as well as from participants at the 2015 China International Conference in Finance and the 2015 Center for Financial Frictions Conference on Efficiently Inefficient Markets. We thank Mengke Zhang for excellent research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Robert F. Stambaugh & Yu Yuan, 2017. "Mispricing Factors," The Review of Financial Studies, vol 30(4), pages 1270-1315. citation courtesy of