Characteristics of pricing errors in stocks implied by autocovariance and 'drag'

Lieven De Moor and Piet Sercu

Applied Economics Letters, 2015, vol. 22, issue 12, 999-1004

Abstract: In this article, we estimate the lower bounds on the volatility and autocorrelation of pricing errors in stocks and infer the market-wide component in the pricing errors, by combining information from the autocovariance and 'drag' in stock returns. For the smaller US stocks, we estimate lower bounds of 8 - 10% for the volatility and 0.3 - 0.5 for the autocorrelation of the pricing errors, at monthly horizon. We infer that approximately 50% of the pricing errors of the smaller stocks originate from the market-wide component, whereas for larger stocks, virtually all of the pricing errors are market-wide. In practice, this evidence means that market-wide bubbles and busts are far more important than idiosyncratic sources of pricing errors, like thin trading, low liquidity or little analyst following.

Date: 2015
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DOI: 10.1080/13504851.2014.995354

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