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Working Paper 273 - Stock (Mis)pricing and investment dynamics in Africa
The study ascertains the extent of mispricing in equity portfolios and mispricing–investment relation using the post financial crisis stock information. A risk-augmented capital asset pricing model (CAPM) is specified to estimate the mispricing in equity portfolios while the mispricing– investment relationship model follows Mohammed (2006). For all the estimations, the regressions are run on daily data from 5 January 2010 to 30 December 2015. First, the results show the presence of transient mispricing in the portfolios’ returns of African equities regardless of the firms’ liquidity and volatility levels. More so, stronger mispricing is observed using an alternative specification. Second, mispricing causes significant divestment in big-size portfolios. Meanwhile, it is less important in small and medium-size portfolios. It further causes overinvestment in medium stock portfolios while effects of over-valuation prove to be velvety on portfolios across board. The conclusion is that mispricing in a portfolio of equity returns is due to low frequency of trading and noting the evil this could cause on investment in stocks, the paper recommends the jettisoning of investors’ buy and hold trading strategy and encouraging portfolio investors to form stock portfolios with frequently traded stocks so as to lessen the effect of stock mispricing.