Asset pricing for inefficient markets: Evidence from China and India

•We provide a direction of incorporating market sentiments in asset pricing models.•We propose a transformation on original market returns.•We examine the market efficiency using a statistical measure, Hurst exponent.•The model is applicable for inefficient markets and may be useful for investors.

Over last four decades, evidence of market inefficiencies has been widely documented by several scholars for all major stock markets in the globe. Chinese and Indian markets are not exempt. Inefficiencies in these markets are described by many authors as roots of all mispricing. Mispricing might be the outcome of application of familiar asset pricing models which may mislead an investor into adopting inappropriate policies for his new investments or for reallocating his old investments. In an alternative approach, we propose a transformation on original market returns in the objective of relaxing the strong assumption of market efficiency behind application of an asset pricing model. This modification will widen the scope of rational models on asset pricing ranging from an efficient to an inefficient market.