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 anomalies associated with accounting-to-market ratios. Profitability and investment anomalies are due to both risk and mispricing, while other anomalies based on information from financial statements and the stock market are mainly due to mispricing. The study highlights the importance of considering risk and mispricing together in asset-pricing research, especially when the two causes are likely to have opposite effects, as in the case of anomalies relating to financial distress and constraints.