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Exploitable Equity Market Inefficiencies?

Posted in Fundamental Valuation

Do markets exploitably misprice stocks? In their July 2017 paper entitled "Global Market Inefficiencies", Söhnke Bartram and Mark Grinblatt assess the exploitability of deviations from fair stock prices worldwide based on publicly known accounting data. Specifically, they each month:

  1. Regress market capitalizations of all stocks sampled on 21 annual accounting variables from most recently disclosed balance sheets and income/cash flow statements. Returns play no role, suppressing potential snooping bias
  2. Calculate percentage mispricings of stocks as regression residuals (unexplained by accounting variables) divided by market capitalization.
  3. Rank stocks into fifths (quintiles) based on within-country percentage mispricings.
  4. Group stocks in the same quintile across countries globally, by developed or emerging, or by region (Europe, Asia Pacific, Americas, and Africa/Middle East).
  5. Calculate next-month equal-weighted and value-weighted gross returns and alphas by quintile and for a hedge portfolio that is long (short) the most underpriced (overpriced) quintiles. Alphas derive from eight risk factors (market, size, book-to-market, investment, profitability, momentum, short-term reversal, and long-term reversal) calculated by region.
  6. Estimate the impact of quintile portfolio rebalancing frictions on gross returns/alphas.

To suppress rebalancing frictions, they also consider a holding interval of 12 months (averaging returns of 12 overlapping portfolios formed each month and held for a year). They run tests controlling for past returns, earnings surprises, country effects and other possible sources of abnormal returns. Using monthly values of 21 annual accounting variables for more than 25,000 non-financial firms, associated stock returns and stock trading frictions from 36 countries during March 1993 through December 2016, they find that:

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