How Trading Volume Amplifies the Return Effects of Stock Mispricing
Summary
The article summarizes research on how trading volume interacts with equity mispricing. Using monthly US stock portfolios sorted jointly by a mispricing score and turnover, the study finds that volume and subsequent returns move in opposite directions depending on valuation: among stocks classified as undervalued, higher volume is associated with stronger returns, while among overvalued stocks it is associated with weaker returns. The pattern appears with alternative mispricing measures and volume definitions, and persists after several controls, though its strength varies across samples and specifications.
The proposed explanation is that volume can proxy for disagreement among investors, while mispricing measures capture biased expectations; disagreement may magnify pricing errors. The study reports that the effect weakens under a different factor benchmark and after controlling for analyst forecast dispersion, which suggests the measures overlap and that results depend on model choice. The historical US evidence is not a direct validation for other markets or a guarantee of implementable profits; the article explicitly cautions against treating it as investment advice.
Key ideas
- The link between volume and future returns depends on whether stocks are classified as undervalued or overvalued.
- Higher turnover is associated with stronger mispricing-related return spreads in the reported US stock portfolios.
- Investor disagreement may amplify biased expectations, offering a mechanism for the volume interaction.
- The effect is sensitive to benchmark models and overlaps with forecast dispersion and other variables.
- The results come from historical US data and do not establish profitability in other markets.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.