Dispersion in Options Investors' Expectations and Stock Return Predictability
80 Pages Posted: 17 Jan 2014 Last revised: 21 Jun 2018
Date Written: March 17, 2018
We propose a measure of dispersion in options investors’ expectations using the dispersion in trading volume across moneynesses (DISP). DISP exhibits a strong negative predictability for the equity premium, which is in line with theoretical models that predict that higher dispersion in expectations is associated with an overpricing that is subsequently corrected. Moreover, consistent with the implications of such models, we find that the predictive power of DISP mainly stems from relatively optimistic periods and is more pronounced for past winner and growth stocks. We further demonstrate that DISP provides consistently strong predictability across the sample period, unlike the popular analysts’ forecasts dispersion (AFD). This is because in the aftermath of the 2008 financial crisis, AFD is heavily driven by pessimistic forecasts and hence its increase does not reflect a true overpricing. Finally, our results indicate that the information content of DISP is not subsumed by several alternative equity premium predictors.
Keywords: Dispersion in beliefs; Predictability of stock returns; Equity premium; Trading volume dispersion; Out-of-sample predictability; Economic signicance
JEL Classification: G10, G11, G12
Suggested Citation: Suggested Citation