Price discovery and asset pricing

- We test whether price discovery influences asset pricing.
- We estimate time-varying price discovery for a 21 Islamic portfolios.
- Both in-sample and out-of-sample tests reveal that returns are predictable.
- An investor by tracking price discovery devises profitable trading strategies.

This paper tests the hypothesis that price discovery influences asset pricing. Our innovations are twofold. First, we estimate time-varying price discovery for a large number (21) of Islamic stock portfolios. Second, we test using a predictive regression model whether or not price discovery predicts stock excess returns. We find from both in-sample and out-of-sample tests that all 21 portfolio excess returns are predictable. We show that a mean-variance investor by tracking price discovery is able to devise profitable trading strategies.