Market Belief Risk and the Cross-Section of Stock Returns

58 Pages Posted: 8 Dec 2012

See all articles by Rajna Gibson

Rajna Gibson

European Corporate Governance Institute (ECGI); University of Geneva - Geneva Finance Research Institute (GFRI)

Songtao Wang

Shanghai Jiao Tong University

Date Written: November 26, 2012

Abstract

This paper studies the eff ect of market belief risk on the cross-section of stock returns. Using actual and analyst EPS forecast data, we construct the market belief as the cross-sectional average of individual beliefs for all sample stocks, with individual belief de fined as the mean analyst EPS forecast minus the one derived from the Brown and Roze (1979) EPS model. We observe that a portfolio that is long in stocks with the highest sensitivities and short in stocks with the lowest sensitivities to innovations in market belief earns an average yearly return of 5.4%. This positive relationship between market belief risk and stock returns persists after accounting for traditional risk factors and is particularly strong for large-cap stocks. These findings are robust when considering alternative speci cations of market belief risk. Finally, we fi nd that stocks' exposure to market belief risk increases with their market beta, volatility, turnover rate, and their sale-to-asset ratio and decreases with their size, momentum, and analyst coverage.

Keywords: Analysts' EPS Forecasts, Heterogeneous Beliefs, Market Belief Risk, Cross-Section of Stock Returns

JEL Classification: G11, G12, G23

Suggested Citation

Gibson, Rajna and Wang, Songtao, Market Belief Risk and the Cross-Section of Stock Returns (November 26, 2012). Swiss Finance Institute Research Paper No. 12-37, Available at SSRN: https://ssrn.com/abstract=2186429 or http://dx.doi.org/10.2139/ssrn.2186429

Rajna Gibson

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, Geneva 1211
Switzerland
+41.22.379.89.83 (Phone)

Songtao Wang (Contact Author)

Shanghai Jiao Tong University ( email )

1954 Huashan Road
Xuhui District
Shanghai, Shanghai 200030
China
52307652 (Phone)

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