Mispricing and the MAX effect in the Korean stock m

Abstract

This paper explains the MAX Effect in Korean stock market is more significant for stocks that are overpriced. First, following Bali et al. (2011), define MAX as the maximum daily return for the previous month, and construct ten equal-weighted, value-weighted portfolios based on MAX. We show that long low-MAX portfolio and short high-MAX portfolio strategy make significant positive return. Second, there is possibility MAX effect directly attributable to idiosyncratic volatility (IVOL) because it is well known that MAX and IVOL have a large positive correlation and there is negative relation between IVOL and return. We show that IVOL cannot fully explain MAX effect by examine MAX effect is significant even after controlling IVOL. Third, following Stambaugh et al. (2015), we examine whether IVOL Puzzle can be explained by mispricing. Also, by applying the same method to MAX effect, we examine whether MAX effect can be explained by mispricing in Korean stock market.