How Do Risk and Mispricing Contribute to Anomalies?

This study quantifies the contributions of risk and mispricing to a comprehensive set of anomalies identified in the literature. Overall, risk and mispricing contribute equally to these anomalies; however, there is a wide variation across different categories. Mispricing is solely responsible for momentum anomalies, whereas risk is solely responsible for the positive return predictability of accounting-to-market ratios. Profitability and investment anomalies are due to both risk and mispricing, as are other anomalies based on information from financial statements; other anomalies based on information from the stock market are mainly due to mispricing. This study highlights the importance of considering risk and mispricing jointly in asset-pricing research, especially when the two causes are likely to have opposite effects, as in the case of anomalies related to financial distress and constraints