Essays on Asset Mispricing

The financial market is assumed to be rational and efficient. In a perfect market, an asset is priced based on corrections for risk using the market price of risk. However, the real world is full of uncertainties, which give us an opportunity to benefit from mispriced assets. This dissertation is on asset mispricing---two kinds in two asset classes. The first essay, 'On real-estate bubble: Is there a bubble in the Korean housing market?' focuses on the real-estate bubble. A bubble is mispricing defined as an upward price deviation from fundamentals; therefore, a kind of absolute mispricing. A rational explanation for the mispricing is a pricing error in which investors assess fundamentals incorrectly; an irrational approach is that the deviation is caused by speculative fervor. The second essay, 'The investment performance of preferred stock' is on relative mispricing of preferred stock. Relative pricing is the assessment of an asset's correct price given the prices of some other asset (Cochrane, 2005). In the second essay, bond prices are used to examine whether preferred provides higher income at lower risk, a violation of fundamental risk correction---riskier securities must offer higher return. The results of the first essay find both a deviation from fundamentals and high explanatory power of fundamentals in housing price movements. Long-term reversion of price (to rent) to trend is found to signal mispricing but is not quite a bubble because of the lack of irrational fervor. The results of the second essay provide evidence of mispricing in below B non-investment grade preferred returns. The mispricing is attributable to mis-assigning of credit risk, an error in assessing the appropriate level of risk. A seeming violation of relative pricing cannot lead to an arbitrage opportunity due to lack of means and the market illiquidity. Pricing works well for investment grade and BB-rating (where most of preferred is rated) preferred. From the two essays, it can be concluded that suspected-mispricing happens, be it a deviation from fundamentals or violation of relative pricing; however, it never happens in a way that allows to profit from it. The market, therefore, remains efficient.