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RFS Advance Access originally published online on May 25, 2005
Review of Financial Studies 2005 18(3):981-1020; doi:10.1093/rfs/hhi023
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© The Author 2005. Published by Oxford University Press. All rights reserved. For Permissions, please email: journals.permissions@oupjournals.org

Market Frictions, Price Delay, and the Cross-Section of Expected Returns

Kewei Hou
Fisher College of Business, The Ohio State University

Tobias J. Moskowitz
Graduate School of Business, University of Chicago, and NBER

Address correspondence to Kewei Hou, Fisher College of Business, The Ohio State University, 2100 Neil Ave., Columbus, OH 43210, or e-mail: hou.28{at}osu.edu.

We parsimoniously characterize the severity of market frictions affecting a stock using the delay with which its price responds to information. The most delayed firms command a large return premium not explained by size, liquidity, or microstructure effects. Moreover, delay captures part of the size effect, idiosyncratic risk is priced only among the most delayed firms, and earnings drift is monotonically increasing in delay. Frictions associated with investor recognition appear most responsible for the delay effect. The very small segment of delayed firms, comprising only 0.02% of the market, generates substantial variation in average returns, highlighting the importance of frictions.


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