Disagreement and Asset Prices

44 Pages Posted: 15 Dec 2012

See all articles by Bruce I. Carlin

Bruce I. Carlin

University of California, Los Angeles (UCLA) - Anderson School of Management

Francis A. Longstaff

University of California, Los Angeles (UCLA) - Finance Area; National Bureau of Economic Research (NBER)

Kyle Matoba

University of California, Los Angeles (UCLA) - Anderson School of Management

Date Written: December 2012

Abstract

How do differences of opinion affect asset prices? Do investors earn a risk premium when disagreement arises in the market? Despite their fundamental importance, these questions are among the most controversial issues in finance. In this paper, we use a novel data set that allows us to directly measure the level of disagreement among Wall Street mortgage dealers about prepayment speeds. We examine how disagreement evolves over time and study its effects on expected returns, return volatility, and trading volume in the mortgage-backed security market. We find that increased disagreement is associated with higher expected returns, higher return volatility, and larger trading volume. These results imply that there is a positive risk premium for disagreement in asset prices. We also show that volatility in and of itself does not lead to higher trading volume. Rather, it is only when disagreement arises in the market that higher uncertainty is associated with more trading. Finally, we are able to distinguish empirically between two competing hypotheses regarding how information in markets gets incorporated into asset prices. We find that sophisticated investors appear to update their beliefs through a rational expectations mechanism when disagreement arises.

Suggested Citation

Carlin, Bruce I. and Longstaff, Francis A. and Matoba, Kyle, Disagreement and Asset Prices (December 2012). NBER Working Paper No. w18619. Available at SSRN: https://ssrn.com/abstract=2189757

Bruce I. Carlin (Contact Author)

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Francis A. Longstaff

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-2218 (Phone)
310-206-5455 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Kyle Matoba

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

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