Misvaluation comovement, market efficiency and the cross-section of stock returns: Evidence from China

•We examine the misvaluation effect in the Chinese stock market.•The misvaluation effect is related to market efficiency.•Misvaluation comovement and systematic misvaluation exist in the Chinese stock market.•The misvaluation effect is stronger in the Chinese market than in the U.S. market.•The misvaluation effect has weakened after the split-share structure reform in China.

In this study, we examine the relation between stock misvaluation and expected returns in China's A-share market. We measure individual stocks' misvaluation based on their pricing deviation from fundamental values, following Rhodes-Kropf et al. (2005. J. Finan. Econ. 77 (3), 561) and Chang et al. (2013. J. Bank. Finance, forthcoming), and find that the measure has strong and robust return predictive power in the Chinese market. We further form a misvaluation factor and find that misvaluation comovement and systematic misvaluation exist in the Chinese market. A comparison of our results with those of Chang et al. (2013. J. Bank. Finance, forthcoming) reveals that the misvaluation effect is much stronger in the Chinese market than in the U.S market. This evidence is consistent with the notion that the Chinese market is much less efficient than the U.S. market. Finally, we show that the return predictive power of misvaluation has weakened since China launched its split-share structure reform in 2005, which could result from the fact that the reform helps to promote market efficiency.