Dispersion in Options Investors' Expectations and Stock Return Predictability
86 Pages Posted: 6 Oct 2014 Last revised: 12 Jun 2017
Date Written: June 11, 2017
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: Suggested Citation