The Real Effects of Market Inefficiency: Aggregate Versus Cross-Sectional Mispricing

We study the real cost of market inefficiency, distinguishing between two types of market inefficiency: aggregate and cross-sectional mispricing. We argue that the real cost of cross-sectional mispricing is more severe than that of aggregate mispricing. The aggregate mispricing has a relatively small cost because the wealth effect and the substitution effect tend to offset each other.