Innovative Efficiency and Stock Returns

David Hirshleifer, Po-Hsuan Hsu, and Dongmei Li

Journal of Financial Economics, March 2013


We find that innovative efficiency (IE), patents granted per dollar of R&D capital, is a strong positive return predictor after controlling for firm characteristics and adjusting for the Carhart four-factor model. This finding, other factor model tests, and the high Sharpe ratio of the Efficient Minus Inefficient portfolio suggest that mispricing as well as risk contributes to the IE effect. Further tests based upon attention and uncertainty proxies suggest that limited investor attention contributes to the effect. The high weight of the EMI portfolio return in the tangency portfolio suggests that IE captures incremental pricing effects relative to well-known factors.

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