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Overconfidence, Arbitrage, and Equilibrium Asset Pricing
Author(s) -
Daniel Kent D.,
Hirshleifer David,
Subrahmanyam Avanidhar
Publication year - 2001
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/0022-1082.00350
Subject(s) - economics , arbitrage , overconfidence effect , financial economics , capital asset pricing model , volatility (finance) , systematic risk , econometrics , asset (computer security) , arbitrage pricing theory , value (mathematics) , psychology , social psychology , computer security , machine learning , computer science
This paper offers a model in which asset prices reflect both covariance risk and misperceptions of firms' prospects, and in which arbitrageurs trade against mispricing. In equilibrium, expected returns are linearly related to both risk and mispricing measures (e.g., fundamental/price ratios). With many securities, mispricing of idiosyncratic value components diminishes but systematic mispricing does not. The theory offers untested empirical implications about volume, volatility, fundamental/price ratios, and mean returns, and is consistent with several empirical findings. These include the ability of fundamental/price ratios and market value to forecast returns, and the domination of beta by these variables in some studies.