Dispersion in Options Investors' Expectations and Stock Return Predictability

80 Pages Posted: 6 Oct 2014 Last revised: 21 Jun 2018

Panayiotis C. Andreou

Cyprus University of Technology

Anastasios Kagkadis

Lancaster University - Department of Accounting and Finance

Paulo F. Maio

Hanken School of Economics - Department of Finance and Statistics

Dennis Philip

Durham University Business School

Multiple version iconThere are 2 versions of this paper

Date Written: March 17, 2018

Abstract

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 significance

JEL Classification: G10, G11, G12

Suggested Citation

Andreou, Panayiotis C. and Kagkadis, Anastasios and Maio, Paulo F. and Philip, Dennis, Dispersion in Options Investors' Expectations and Stock Return Predictability (March 17, 2018). Available at SSRN: https://ssrn.com/abstract=2506052 or http://dx.doi.org/10.2139/ssrn.2506052

Panayiotis C. Andreou

Cyprus University of Technology ( email )

School Of Management and Economics
P.O. Box 50329
Lemesos, 3036
Cyprus

HOME PAGE: http://www.pandreou.com

Anastasios Kagkadis (Contact Author)

Lancaster University - Department of Accounting and Finance ( email )

The Management School
Lancaster LA1 4YX
United Kingdom

Paulo F. Maio

Hanken School of Economics - Department of Finance and Statistics ( email )

FI-00101 Helsinki
Finland

HOME PAGE: http://sites.google.com/site/paulofmaio/home

Dennis Philip

Durham University Business School ( email )

Department of Economics and Finance
Mill Hill Lane
Durham, DH1 3LB
United Kingdom

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