Heterogeneous Beliefs, Investor Holding Horizon and the Neoclassical Q-Theory of Investment

Abstract

This paper studies how the negative relation between expected return and real investment derived from the neoclassical q-theory changes with the degree of mispricing and investor holding horizon. Using analyst forecast dispersion as a proxy for overpricing generated by heterogeneous beliefs and institutional holdings as a proxy for investor holding horizon, I show that: (i) when investors have short holding horizon, the negative return-investment relation predicted by the standard q-theory continues to hold under overpricing; (ii) when there is no mispricing, investor holding horizon does not affect the return-investment relation; and (iii) when there is a high degree of mispricing, the existence of long-term investors significantly weakens the negative relation between expected return and investment, providing evidence that long-term investors prevent firm investment from co-moving with speculative components in asset prices. The empirical results cannot be fully explained by alternative explanations, such as limits-to-arbitrage and a simple q-theory with investment frictions.

Keywords: Q-theory of investment, Investment-related asset pricing anomalies, Heterogeneous beliefs, Investor holding horizon

JEL Classification: G1, E2