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The R&D anomaly: Risk or mispricing?

Woon Sau Leung, Kevin P. Evans and Khelifa Mazouz

Journal of Banking & Finance, 2020, vol. 115, issue C

Abstract: We offer new evidence on the risk versus mispricing explanations for the R&D anomaly. Return covariance with a characteristic-based factor captures the cross-sectional return variation on R&D portfolios not explained by asset pricing models. This is consistent with both covariance risk and mispricing. Under the framework of the ICAPM, we find little economic justification that an R&D factor is a proxy for innovations to a state variable. The characteristic subsumes the factor loading in direct tests, providing support to the mispricing hypothesis. Investigating the mispricing explanation further, we reject the assertion that the R&D anomaly arises from the correction of stocks mispriced by investor sentiment. A natural experiment exploiting the pilot program under Regulation SHO shows no evidence that the anomaly persists due to limits to arbitrage in the form of short sale constraints.

Keywords: R&D anomaly; Covariance risk; ICAPM; Mispricing (search for similar items in EconPapers)
JEL-codes: G12 G14 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1016/j.jbankfin.2020.105815

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Handle: RePEc:eee:jbfina:v:115:y:2020:i:c:s0378426620300820