Asset Prices When Investors Ignore Discount Rate Dynamics

Abstract

I propose and test a unifying hypothesis to explain both cross-sectional return anomalies and subjective return expectation errors: some investors ignore discount rate dynamics when forming return expectations. Consistent with the hypothesis: (1) stocks' expected cash flow growth and idiosyncratic volatility explain the significant cross-sectional variation of analysts' return forecast errors; (2) a measure of mispricing at the firm level strongly predicts stock returns, even among stocks in the SP (3) a tradable mispricing factor explains the CAPM alphas of 12 leading anomalies including investment, profitability, beta, idiosyncratic volatility, and cash flow duration.