Risk Sharing, Costly Participation, and Monthly Returns

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Abstract
We identify long-lived pricing errors through a model in which inattentive investors arrive stochastically to trade. The model’s parameters are structurally estimated using daily NYSE market-maker inventories, retail order flows, and prices. The estimated model fits empirical variances, autocorrelations, and cross-autocorrelations among our three data series from daily to monthly frequencies. Pricing errors for the typical NYSE stock have a standard deviation of 2.9 percentage points and a half-life of 3.0 weeks. These pricing errors account for 27% of daily and 19% of monthly idiosyncratic return variances.