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Risk or Mispricing? Cross-Country Evidence on the Cross-Section of Stock Returns

Using a novel collection of market characteristics from 40 countries, this paper test competing explanations behind five major anomalies classified in Hou, Xue, and Zhang (2015): momentum, value-growth, investment, profitability, and trading frictions. Results show that anomaly returns highly correlate with proxies for market efficiency, investor protection, limits-to-arbitrage, and investor irrationality. New to existing studies, results favor a limits-to-arbitrage explanation for momentum effect, and a mispricing explanation for value-growth and investment effects. Results also suggest that profitability effect may be a result of both rational risk pricing and market inefficiency while remain silent on the cause of trading frictions effect. These findings have new implications on return predictability in both U.S. and international markets.