Disagreement, Excess Volatility and Comovement in Stock Returns

54 Pages Posted: 4 Apr 2012 Last revised: 22 Jul 2017

See all articles by Xuezhong He

Xuezhong He

Xi'an Jiaotong-Liverpool University (XJTLU)

Lei Shi

Macquarie University; Financial Research Network (FIRN)

Date Written: July 20, 2017

Abstract

This paper analyzes the impact of dispersion and correlation in investors’ beliefs on the cross-section of volatilities and correlations in stock returns. Theoretically, we show that, in a baseline model with logarithmic agents and constant beliefs, there is a positive relationship between belief dispersion and stock volatility, and a positive relationship between belief correlation and return correlation. Extensions to CRRA preference, learning, and multiple agents show that the baseline results are generally robust for reasonable model parameter values. Empirically, we find supporting evidence on the theoretical predictions of the baseline model using analysts’ forecasts of earnings as a proxy for investors’ beliefs, suggesting that disagreement provides a plausible explanation to the excess volatility and comovement in stock returns.

Keywords: Excess volatility; Excess comovement; Belief dispersion; Belief correlation; General equilibrium

JEL Classification: G12, D84

Suggested Citation

He, Xue-Zhong 'Tony' and Shi, Lei, Disagreement, Excess Volatility and Comovement in Stock Returns (July 20, 2017). Available at SSRN: https://ssrn.com/abstract=2032899 or http://dx.doi.org/10.2139/ssrn.2032899

Xue-Zhong 'Tony' He

Xi'an Jiaotong-Liverpool University (XJTLU) ( email )

111 Renai Road, SIP
, Lake Science and Education Innovation District
Suzhou, JiangSu province 215123
China

Lei Shi (Contact Author)

Macquarie University ( email )

New South Wales 2109
Australia
+612 98508478 (Phone)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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