The Mispricing Return Premium

Michael J. Brennan and Ashley W. Wang

The Review of Financial Studies, 2010, vol. 23, issue 9, 3437-3468

Abstract: We show that, when stock prices are subject to stochastic mispricing errors, expected rates of return may depend not only on the fundamental risk that is captured by a standard asset pricing model, but also on the type and degree of asset mispricing, even when the mispricing is zero on average. Empirically, the mispricing induced return premium, either estimated using a Kalman filter or proxied by the volatility and variance ratio of residual returns, is shown to be significantly associated with realized risk-adjusted returns. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

Date: 2010
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