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Analyst Disagreement, Mispricing, and Liquidity




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    • Ronnie Sadka is at the University of Washington Business School; and Anna Scherbina is at Harvard Business School. We are grateful to Rob Stambaugh (the editor) and an associate editor. Special thanks are due to an anonymous referee for many constructive and illuminating comments and suggestions, which immensely helped us improve the paper. We also thank Malcolm Baker; Shmuel Baruch; Ken French; Alan Hess; Ravi Jagannathan; Li Jin; Avi Kamara; Robert Korajczyk; Jennifer Koski; Arvind Krishnamurthy; Ed Rice; Efraim Sadka; Gil Sadka; Michael Schwarz; George Skoulakis; Erik Stafford; Tuomo Vuolteenaho; seminar participants at the University of Washington Business School, Harvard Business School, Center for Financial Studies, Dartmouth/Tuck, University of Illinois at Urbana-Champaign, London Business School, University of North Carolina, Erasmus University, Tilburg University, NBER Market Microstructure Meeting (Summer 2004), Notre Dame Behavioral Finance Conference, Frontiers of Finance Conference (2005), NBER Universities Research Conference (Asset Pricing with Imperfect Trading, 2005), French Finance Association Meetings (Summer 2005), European Finance Association Meetings (2005); and our discussants, Paul Irvine (NBER Market Microstructure), Rick Mendenhall (Notre Dame), Tom Berglund (Frontiers of Finance), Adam Reed (NBER Universities Research Conference), Isabelle Platten (French Finance Association), and Jos van Bommel (European Finance Association) for helpful suggestions. We would also like to thank I/B/E/S for making its data available for our research. We are responsible for any errors.


This paper documents a close link between mispricing and liquidity by investigating stocks with high analyst disagreement. Previous research finds that these stocks tend to be overpriced, but that prices correct downwards as uncertainty about earnings is resolved. Our analysis suggests that one reason mispricing has persisted through the years is that analyst disagreement coincides with high trading costs. We also show that in the cross-section, the less liquid stocks tend to be more severely overpriced. Additionally, increases in aggregate market liquidity accelerate the convergence of prices to fundamentals. As a result, returns of the initially overpriced stocks are negatively correlated with the time series of innovations in aggregate market liquidity.