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The Price Is (Almost) Right





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    • Cohen is at Harvard Business School; Polk is at the London School of Economics; and Vuolteenaho is at Arrowstreet Capital, L.P. We would like to thank Ken French for providing us with some of the data used in this study. We are grateful to Gregor Andrade, John Campbell, John Cochrane, Josh Coval, Kent Daniel (discussant), Eugene Fama, Wayne Ferson (discussant), Kenneth French, John Heaton, Matti Keloharju, Owen Lamont, Rafael La Porta, Andre Perold, Antti Petäjistö, Vesa Puttonen, William Schwert, Jay Shanken, Andrei Shleifer, Jeremy Stein, and Sheridan Titman (discussant) for their comments and suggestions. We would also like to thank seminar participants at the American Finance Association 2003 meeting, Chicago Quantitative Alliance Spring 2002 meeting, European Finance Association 2002 and 2005 meetings, Harvard University Economics Department, Helsinki School of Economics and Business Administration, Kellogg School of Management (Northwestern), NBER Asset Pricing Program Meeting, Simon School (Rochester), Stanford Graduate School of Business, Texas Finance Festival, and Tuck School (Dartmouth). An earlier draft of this paper was circulated under the title “Does Risk or Mispricing Explain the Cross-section of Stock Prices?”


Most previous research tests market efficiency using average abnormal trading profits on dynamic trading strategies, and typically rejects the joint hypothesis of market efficiency and an asset pricing model. In contrast, we adopt the perspective of a buy-and-hold investor and examine stock price levels. For such an investor, the price level is more relevant than the short-horizon expected return, and betas of cash flow fundamentals are more important than high-frequency stock return betas. Our cross-sectional tests suggest that there exist specifications in which differences in relative price levels of individual stocks can be largely explained by their fundamental betas.