Extrapolative Beliefs in the Cross-Section: What Can We Learn from the Crowds?
57 Pages Posted: 22 Mar 2018 Last revised: 7 Apr 2020
Date Written: March 25, 2020
Using novel data from a crowdsourcing platform for ranking stocks, we investigate how investors form expectations about stock returns over the next week. We find that investors extrapolate from stocks' recent past returns, with more weight on more recent returns, especially when recent returns are negative, salient, or from a dispersed cross-section. Such extrapolative beliefs are stronger among non-professionals and large stocks. Moreover, consensus rankings negatively predict returns over the next week, more so among stocks with low institutional ownership and high degree of extrapolation. A trading strategy that sorts stocks on investor beliefs generates an economically significant profit.
Keywords: return extrapolation; beliefs in the cross-section; expectation formation
JEL Classification: G4; G12
Suggested Citation: Suggested Citation