In this paper, Assistant Professor Anna Scherbina and co-author Ronnie Sadka from Boston College document 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. The authors’ analysis suggests that one reason mispricing has persisted through the years is that analyst disagreement coincides with high trading costs.

The authors 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.

This paper was a runner-up for the 2005 European Finance Association Best Paper Award.