Analyst Disagreement, Mispricing and Liquidity
We 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 prices correct down as uncertainty about earnings is resolved. We conjecture that one reason mispricing has persisted is that analyst disagreement coincides with high trading costs. Indeed, we show that in the cross-section the less liquid stocks tend to be more severely overpriced. Additionally, increases in aggregate market liquidity accelerate 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.