Dispersion in Options Investors' Expectations and Stock Return Predictability

86 Pages Posted: 6 Oct 2014 Last revised: 12 Jun 2017

Panayiotis C. Andreou

Cyprus University of Technology

Anastasios Kagkadis

Lancaster University - Department of Accounting and Finance

Paulo F. Maio

Hanken School of Economics - Department of Finance and Statistics

Dennis Philip

Durham University Business School

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Date Written: June 11, 2017

Abstract

We propose a measure of dispersion in options investors' expectations using the dispersion in trading volume across moneynesses (DISP). DISP exhibits strong negative predictability for the equity premium, which can be explained within a framework where dispersion leads to overpricing and subsequent downturn. In line with this, the predictive power of DISP mainly stems from relatively optimistic periods and is more pronounced for past winner and growth stocks. Moreover, DISP provides consistently strong predictability across the sample period, while the dispersion in analysts’ forecasts loses its forecasting power in recent years due to a pessimistic bias following the 2008 crisis.

Keywords: Dispersion in beliefs; Predictability of stock returns; Equity premium; Trading volume dispersion; Out-of-sample predictability; Economic significance

JEL Classification: G10, G11, G12

Suggested Citation

Andreou, Panayiotis C. and Kagkadis, Anastasios and Maio, Paulo F. and Philip, Dennis, Dispersion in Options Investors' Expectations and Stock Return Predictability (June 11, 2017). Available at SSRN: https://ssrn.com/abstract=2506052 or http://dx.doi.org/10.2139/ssrn.2506052

Panayiotis C. Andreou

Cyprus University of Technology ( email )

School Of Management and Economics
P.O. Box 50329
Lemesos, 3036
Cyprus

HOME PAGE: http://www.pandreou.com

Anastasios Kagkadis (Contact Author)

Lancaster University - Department of Accounting and Finance ( email )

The Management School
Lancaster LA1 4YX
United Kingdom

Paulo F. Maio

Hanken School of Economics - Department of Finance and Statistics ( email )

FI-00101 Helsinki
Finland

Dennis Philip

Durham University Business School ( email )

Department of Economics and Finance
Mill Hill Lane
Durham, DH1 3LB
United Kingdom

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