The excess returns of "quality" stocks: a behavioral anomaly

This paper investigates the causes of the quality anomaly, which is one of the strongest and most scalable anomalies in equity markets. We explore two potential explanations. The "risk view", whereby investing in high-quality firms is somehowriskier, so that the higher returns of a quality portfolio are a compensation for risk exposure, is consistent with the efficient market hypothesis. The "behavioral view" states that some investors persistently underestimate the true value of high-quality firms. We find no evidence in favor of the "risk view": the returns from investing in quality firms are abnormally high on a risk-adjusted basis, and are not prone to crashes. We provide novel evidence in favor of the "behavioral view": in their forecasts of future prices, and while being overall over-optimistic, analysts systematically underestimate the future returns of high-quality firms compared with those of low-quality firms.