42 Pages Posted: 17 Jun 2016 Last revised: 2 Aug 2018
Date Written: July 20, 2018
When two investors agree to disagree on future market prospects and bet against each other, they both expect to profit from their trades. Hence, an increase in the disagreement magnitude leads to higher perceived trading profits for both investors and consequently lower marginal utilities, and disagreement betas price cross-sectional asset returns. We construct a disagreement measure based on professional forecasts of U.S. macroeconomic fundamentals. Betas with respect to this single disagreement factor positively explain cross-sectional returns of U.S. assets, such as stocks, corporate bonds, mortgage-backed securities, and government securities. Further tests using disagreement beta portfolios and broad sets of portfolio-based test assets confirm the significant pricing power of the disagreement factor on top of influential benchmark factors. The disagreement beta effect is also shown to be distinct from the disagreement effect with short-sale constraints and uncertainty beta effect.
Keywords: Disagreement, heterogeneous beliefs, speculation, asset pricing
JEL Classification: G10, G12, G13, F37
Suggested Citation: Suggested Citation