Can Efficiency of Returns Be Considered as a Pricing Factor?

We add to the investments literature by employing new techniques to estimate asset performance. We estimate a data envelopment analysis based efficiency score that allows for direct comparison between ex-post efficiency rankings and test the ex-ante relevance of such scores by including them into asset pricing models. We find that knowing the fund efficiency score can help explain time-series returns. When efficiency is included in an asset pricing model, the absolute value of the average mispricing error is decreased, which we take as evidence of the explanatory power of efficiency scores. But more importantly, we show that efficacy scores can be used as next period predictors of stock returns. In addition, we further use the efficiency scores to differentiate between the performance of constrained and unconstrained investment assets, as in the case of socially responsible investments. Our findings give robustness to the literature on constrained investments showing significant underperformance of socially and responsible investments.