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.