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Mispricing in linear asset pricing models

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  • Qiang Kang

Abstract

In the framework of a reduced-form asset pricing model featuring linear-in-instrument betas and time-varying risk premiums and allowing for missing factors, I propose a measure of mispricing that is largely free from the bias due to missing factors or missing instruments. Applying the model to U.S. equity data, I find evidence of mispricing in stock returns. A mispricing-based zero-dollar investment strategy intersecting momentum and contrarian horizons is highly profitable when applied to both firm- and portfolio-level returns, even after controlling for Fama-French factors, momentum and liquidity effects. Focusing on momentum, I find that the phenomenon is partially caused by the mispricing that does not vary with macro variables. Time-varying betas reduce the mispricing by 40% or better.

Suggested Citation

  • Qiang Kang, 2025. "Mispricing in linear asset pricing models," Applied Economics, Taylor & Francis Journals, vol. 57(11), pages 1196-1220, March.
    • Handle: RePEc:taf:applec:v:57:y:2025:i:11:p:1196-1220
    DOI: 10.1080/00036846.2024.2311733
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