What Percentage of Common Stocks are Mispriced?

36 Pages Posted: 10 Jul 2001

See all articles by Kevin C.H. Chiang

Kevin C.H. Chiang

University of Alaska Fairbanks - School of Management (SOM); Louisiana State University, Baton Rouge - Department of Finance

Ji-Chai Lin

Hong Kong PolyU

R. Kelley Pace

Louisiana State University - E.J. Ourso College of Business Administration

Date Written: May 7, 2001

Abstract

Recent empirical studies on asset pricing have generally concluded that the CAPM cannot explain the cross-sectional returns on common stocks. If stock markets are not in equilibrium, what percentage of common stocks are mispriced? Answers to this question have broad implications for market efficiency, performance evaluation, and investment strategies. To address this question, we propose a new test framework to examine the pricing of individual common stocks. The framework is based on a gain-loss asset pricing model (GLAPM), which formulates the reward of gain needed to compensate for the risk of loss under the paradigm of expected utility maximization. The GLAPM can unify the CAPM and the mean-lower partial moment models. From simulations, we show that the test framework has adequate power to reject the null hypothesis of no mispricing when it is false. Our empirical results suggest that, after properly taking into account the type-I errors, on average, no more than 1% of U.S. common stocks are mispriced during the sample period, 1948-1997. Furthermore, the GLAPM performs slightly better in explaining the gain-loss tradeoff of the sample stocks than the CAPM in explaining their mean-variance tradeoff.

Suggested Citation

Chiang, Kevin C.H. and Lin, Ji-Chai and Pace, R. Kelley, What Percentage of Common Stocks are Mispriced? (May 7, 2001). Available at SSRN: https://ssrn.com/abstract=276172 or http://dx.doi.org/10.2139/ssrn.276172

Kevin C.H. Chiang (Contact Author)

University of Alaska Fairbanks - School of Management (SOM) ( email )

P.O. Box 756080
208C Bunnell Building
Fairbanks, AK 99775-0500
United States
907-474-7049 (Phone)
907-474-5219 (Fax)

Louisiana State University, Baton Rouge - Department of Finance ( email )

E.J. Ourso College of Business Administration
Baton Rouge, LA 70803
United States
225-753-4978 (Phone)
225-388-6366 (Fax)

Ji-Chai Lin

Hong Kong PolyU ( email )

M715, Li Ka Shing Tower
Hung Hom, Kowloon
China

R. Kelley Pace

Louisiana State University - E.J. Ourso College of Business Administration ( email )

Department of Finance
2164 B Patrick F. Taylor Hall
Baton Rouge, LA 70803-6308
United States
(225)-578-6256 (Phone)
(225)-578-9065 (Fax)

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