Hedge Funds, Misvaluation, and The HML Factor Returns

We measure misvaluation using the discounted residual income model of Ohlson (1990, 1995). We show that there are significant returns on a long-short portfolio that buys under- and sells short overvalued shares. These returns are highly correlated with the Fama and French HML factor returns and including the returns in a factor model yields the HML factor redundant. Misvaluation spread, defined as the difference in misvaluation between over- and undervalued shares, forecasts both the misvaluation portfolio's and the HML factor returns. Hedge fund flows reduce the misvaluation spread and the expected returns on the misvaluation portfolio and the HML factor