Working Paper

Information diffusion based explanations of asset pricing anomalies

Abstract: In this paper we develop information based factors which outperform other popular factors used in the multifactor pricing literature such as the Fama and French size and book-to-market factors. The first factor is based on the age of an asset, measured by the number of months since the asset?s IPO, while the second factor is based on the percentage of trading days an asset does not trade in a given year. Both factors attempt to capture the quality and speed of information diffusion on the market. Our information factors perform particularly well on momentum portfolios, which, Hong et al (2000) have shown to result from gradual-information diffusion. This gradual information diffusion explanation is consistent with the information argument underlying our factors, namely that, assets plagued with information problems can be miss-priced for sustained periods of time. Furthermore, our multifactor model successfully prices most industry portfolios and performs as well as the Fama and French model when pricing the 25 size/book-to-market sorted portfolios.

Keywords: Investments; Stock market; Asset pricing; Capital assets pricing model;

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Bibliographic Information

Provider: Federal Reserve Bank of Boston

Part of Series: Supervisory Research and Analysis Working Papers

Publication Date: 2007

Number: QAU07-6