Predictability Concentrates in Bad Times. And so Does Disagreement

26 Pages Posted: 15 May 2019 Last revised: 26 Jun 2019

See all articles by Thiago de Oliveira Souza

Thiago de Oliveira Souza

University of Southern Denmark; Danish Finance Institute

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Date Written: June 25, 2019

Abstract

Within a standard risk-based asset pricing framework with rational expectations, realized returns have two components: Predictable risk premiums and unpredictable shocks. In bad times, the price of risk increases. Hence, the predictable fraction of returns - and predictability - increases. "Disagreement" (dispersion in analyst forecasts) also intensifies in bad times if (i) analysts report (close to) risk-neutral expectations weighted by state prices, which become more volatile, or (ii) dividend volatility changes with the price of risk - for example, because consumption volatility changes. In both cases, individual analysts produce unbiased forecasts based on partial information.

Keywords: predictability, bad times, efficient market hypothesis, disagreement, rational expectations

JEL Classification: G11, G12, G14

Suggested Citation

de Oliveira Souza, Thiago, Predictability Concentrates in Bad Times. And so Does Disagreement (June 25, 2019). Available at SSRN: https://ssrn.com/abstract=3378228 or http://dx.doi.org/10.2139/ssrn.3378228

Thiago De Oliveira Souza (Contact Author)

University of Southern Denmark ( email )

Campusvej 55
DK-5230 Odense, 5000
Denmark

Danish Finance Institute ( email )

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