Disagreement in Economic Forecasts and Equity Returns: Risk or Mispricing?

Abstract

We quantify disagreement about the economy with ex-ante measures of divergence of opinion among economic forecasters and investigate if economic disagreement has a significant impact on the cross-sectional pricing of individual stocks. We find a significant disagreement premium of 7.2% per annum, induced by both outperformance of stocks with negative disagreement beta and underperformance of stocks with positive disagreement beta. We show that in the sample of undervalued (overvalued) stocks, those with negative (positive) disagreement beta are most undervalued (overvalued) in the portfolio formation month and hence earn significantly positive (negative) alpha. Disagreement premium is also found to be weak in the sample of fairly priced stocks. Thus, our results support the mispricing and arbitrage risk hypotheses that the positive (negative) disagreement beta provides an indirect way to measure dispersed opinion and overpricing (underpricing).

Keywords: dispersion in economic forecasts, mispricing, disagreement risk, cross-section of stock returns, return predictability

JEL Classification: G11, G12, C13, E20, E30