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Information uncertainties and asset pricing puzzles: risk or mispricing?

Keming Li, Mohammad Riaz Uddin and J. David Diltz

Managerial Finance, 2015, vol. 41, issue 12, 1280-1297

Abstract: Purpose - – Prior research has documented the role of information uncertainty in the cross-sectional variation in stock returns. Miller (1977) hypothesizes that if information uncertainty is caused by differences of opinion, prices will reflect only the positive beliefs due to short-sale constraints. These anomalous stock price behaviors may result from mispricing. In contrast, Merton (1974) asserts that default risk is a function of the uncertainty in the asset value process. Information uncertainty may be subsumed by credit or default risk. The paper aims to discuss these issues. Design/methodology/approach - – The authors employ various sorting techniques and Fama-MacBeth Regressions to test the hypotheses. Findings - – The authors provide empirical evidence consistent with Merton’s (1974) default risk hypothesis and inconsistent with Miller’s (1977) mispricing hypothesis. Research limitations/implications - – Risk aversion and not misplacing is the primary factor driving information-related anomalies in equities markets. Practical implications - – It would be quite difficult to find arbitrage opportunities in equities markets because there appears to be little, if any, mis-pricing due to information uncertainties. Originality/value - – This study provides important information about the primary underlying information-related source of certain empirical anomalies in the cross-section of stock returns.

Keywords: Uncertainty; Returns; Information; Cross-section (search for similar items in EconPapers)
Date: 2015
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