The mispricing of equity risk: behavioral and corporate leverage factors

Abstract

In this paper, we investigate the risk anomaly in equity market. Our focus is to assess the relationship between skewness preference, investor sentiment, corporate leverage and the mispricing of equity risk. Based on data of all the firms of the CAC All Tradable index over the period 2005 and 2015, we find that investor preference for skewed stocks and investor sentiment are strong predictors of stock returns. In particular, they are positively related to both market and total risks. This result supplies evidence that investor irrationality maters in stocks’ valuation. In addition, we find that that leverage is inversely related to equity risk and explains why French stocks are undervaluated. Our results are robust to the usage of different measures of total investor sentiment and corporate leverage.