LAUSR

This paper explores the mispricing relative to the capital asset pricing model through an equilibrium model. We find that both the strong risk preference dependent on good market states and strong risk aversion dependent on bad market states can produce high mispricing. Choosing the China stock market, the largest emerging market dominated by individual investors and known for its volatile nature in a short history as our sample, the empirical results also support our theoretical findings. Overall, our paper sheds light on the mispricing caused by the investor’s risk preference reference-dependent on market states.