Inflation, Heterogeneous Beliefs, and Mispricing

Abstract

This paper studies whether heterogeneous beliefs on inflation affect the mispricing in the stock market. Heterogeneous beliefs are particularly strong following periods of highly volatile inflation. To empirically test whether heterogeneous beliefs on inflation lead to mispricing, I entertain the possibility that anomalies at least partially reflect mispricing. I find that, following high inflation periods, anomalies are stronger and the returns on the short-leg portfolios are lower. The key explanation is that, following high inflation periods, the most optimistic belief about stocks tends to be overly optimistic, as a result, stocks tend to be overpriced.

Keywords: Money Illusion, Mispricing, Inflation, Heterogeneous Beliefs, Return Predictability

JEL Classification: G02, G12, E31