Extrapolative Beliefs in the Cross-Section: What Can We Learn from the Crowds?
53 Pages Posted: 22 Mar 2018 Last revised: 8 May 2019
Date Written: May 4, 2019
Using novel data from a crowdsourcing platform for ranking stocks, we investigate how individuals form expectations about future stock returns in the cross-section. We find that investors extrapolate from stocks' recent past returns, with more weight on more recent returns, especially when recent returns are negative or salient. Such extrapolative beliefs are stronger among non-professionals. Moreover, consensus rankings negatively predict future stock returns, more so among stocks with low institutional ownership and high degree of extrapolation, consistent with the asset pricing implications of extrapolative beliefs. 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
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