Learning from Prices and the Dispersion in Beliefs

48 Pages Posted: 15 Nov 2008 Last revised: 6 May 2010

Snehal Banerjee

University of California, San Diego (UCSD) - Rady School of Management

Date Written: May 5, 2010

Abstract

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.

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

Suggested Citation

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

Snehal Banerjee (Contact Author)

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States

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