Disagreement Beta

42 Pages Posted: 17 Jun 2016 Last revised: 2 Aug 2018

George Gao

T. Rowe Price; Cornell University - Samuel Curtis Johnson Graduate School of Management

Xiaomeng Lu

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Zhaogang Song

Johns Hopkins University - Carey Business School

Hongjun Yan

Driehaus College of Business, DePaul University

Date Written: July 20, 2018

Abstract

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

Gao, George and Lu, Xiaomeng and Song, Zhaogang and Yan, Hongjun, Disagreement Beta (July 20, 2018). Available at SSRN: https://ssrn.com/abstract=2796203 or http://dx.doi.org/10.2139/ssrn.2796203

George Gao

T. Rowe Price ( email )

Baltimore, MD 21297-1215
United States

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Sage Hall 314
Ithaca, NY 14853
United States

Xiaomeng Lu

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

Zhaogang Song (Contact Author)

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

Hongjun Yan

Driehaus College of Business, DePaul University ( email )

1 East Jackson Blvd.
Chicago, IL 60604
United States

HOME PAGE: http://sites.google.com/site/hongjunyanhomepage/

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