Volatility, Investor Uncertainty, and Dispersion

35 Pages Posted: 24 Dec 2011 Last revised: 3 Mar 2012

See all articles by Ronald Huisman

Ronald Huisman

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)

Nico van der Sar

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)

Remco C. J. Zwinkels

Vrije Universiteit Amsterdam; Tinbergen Institute - Tinbergen Institute Amsterdam (TIA)

Date Written: December 23, 2011

Abstract

This paper studies the aggregation of investor expectations of stock market return variation and its implications. We motivate theoretically that the market's expected return variance can be decomposed into the average of individuals' expected variance plus the dispersion in individuals' expected mean returns. The former can be seen as risk, while the latter is a measure of uncertainty. We illustrate this result empirically by setting up a unique survey measuring investors' expected returns and volatilities. Our finding is important to the issue of aggregating heterogeneous beliefs at the micro level in relation to pricing in financial markets. For instance, as a result it is almost per definition that individual investors are overconfident in the sense of overly narrow forecast bounds, due to neglecting individual differences of opinion about mean returns. We furthermore show that investors display a risk-return trade-off, whereas the market seems to price uncertainty.

Keywords: volatility, uncertainty, dispersion, survey data

JEL Classification: G11, D03

Suggested Citation

Huisman, Ronald and van der Sar, Nico and Zwinkels, Remco C.J., Volatility, Investor Uncertainty, and Dispersion (December 23, 2011). Available at SSRN: https://ssrn.com/abstract=1976229 or http://dx.doi.org/10.2139/ssrn.1976229

Ronald Huisman

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

Nico Van der Sar

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

Remco C.J. Zwinkels (Contact Author)

Vrije Universiteit Amsterdam ( email )

De Boelelaan 1105
Amsterdam, NL-1081HV
Netherlands
+31 20 59 85220 (Phone)

HOME PAGE: http://research.vu.nl/en/persons/remco-zwinkels

Tinbergen Institute - Tinbergen Institute Amsterdam (TIA) ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

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