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Learning from Prices and the Dispersion in Beliefs

Snehal Banerjee

Kellogg School of Management - Department of Finance

May 5, 2010

I develop a dynamic model that nests the rational expectations (RE) and differences of opinion (DO) approaches to study how investors use prices to update their valuations. I show that when investors condition on prices (RE), investor disagreement is related positively to expected returns, return volatility and market beta, but negatively to return autocorrelation. When investors do not use prices (DO), these relationships are reversed. I test these predictions on the cross-section of stocks using analyst forecast dispersion and volume as proxies for disagreement, and find empirical evidence that is consistent with investors using prices on average.

Number of Pages in PDF File: 48

Keywords: rational expectations, difference of opinions, overlapping generations, disagreement

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Date posted: November 15, 2008 ; Last revised: May 6, 2010

Suggested Citation

Banerjee, Snehal, Learning from Prices and the Dispersion in Beliefs (May 5, 2010). Available at SSRN: http://ssrn.com/abstract=1300969 or http://dx.doi.org/10.2139/ssrn.1300969

Contact Information

Snehal Banerjee (Contact Author)
Kellogg School of Management - Department of Finance ( email )
Evanston, IL 60208
United States
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