Correlated Beliefs, Returns, and Stock Market Volatility

51 Pages Posted: 25 Aug 2015 Last revised: 12 Mar 2022

See all articles by Joel David

Joel David

Federal Reserve Bank of Chicago

Ina Simonovska

University of California - Davis; National Bureau of Economic Research (NBER)

Date Written: August 2015

Abstract

Firm-level stock returns exhibit comovement above that in fundamentals, and the gap tends to be higher in developing countries. We investigate whether correlated beliefs among sophisticated, but imperfectly informed, traders can account for the patterns of return correlations across countries. We take a unique approach by turning to direct data on market participants’ information - namely, real-time firm-level earnings forecasts made by equity market analysts. The correlations of firm-level forecasts exceed those of fundamentals and are strongly related to return correlations across countries. A calibrated information-based model demonstrates that the correlation of beliefs implied by analyst forecasts leads to return correlations broadly in line with the data, both in levels and across countries - the correlation between predicted and actual is 0.63. Our findings have implications for market-wide volatility - the model-implied correlations alone can explain 44% of the cross-section of aggregate volatility. The results are robust to controlling for a number of alternative factors put forth by the existing literature.

Suggested Citation

David, Joel and Simonovska, Ina, Correlated Beliefs, Returns, and Stock Market Volatility (August 2015). NBER Working Paper No. w21480, Available at SSRN: https://ssrn.com/abstract=2649748

Joel David (Contact Author)

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

Ina Simonovska

University of California - Davis ( email )

1 Shields Ave
Davis, CA 95616
United States

HOME PAGE: http://inasimonovska.weebly.com/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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