Belief Overreaction and Stock Market Puzzles

62 Pages Posted: 2 Jun 2020 Last revised: 15 Aug 2022

See all articles by Pedro Bordalo

Pedro Bordalo

University of Oxford - Said Business School

Nicola Gennaioli

Bocconi University - Department of Finance; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research

rafael laporta

Brown University

Andrei Shleifer

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Date Written: May 2020

Abstract

We construct an index of long term expected earnings growth for S&P500 firms and show that it has remarkable power to jointly predict errors in these expectations and stock returns, in both the aggregate market and the cross section. The evidence supports a mechanism whereby good news cause investors to become too optimistic about earnings growth, for the market as a whole but especially for specific firms. This leads to inflated stock prices and, as beliefs are systematically disappointed, to subsequent low returns in the aggregate market and for specific firms in the cross section. Overreaction of measured long-term expectations helps resolve major asset pricing puzzles without time series or cross-sectional variation in required returns.

Suggested Citation

Bordalo, Pedro and Gennaioli, Nicola and laporta, rafael and Shleifer, Andrei, Belief Overreaction and Stock Market Puzzles (May 2020). NBER Working Paper No. w27283, Available at SSRN: https://ssrn.com/abstract=3615480

Pedro Bordalo (Contact Author)

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain

Nicola Gennaioli

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136
Italy

Rafael Laporta

Brown University

Andrei Shleifer

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States
617-495-5046 (Phone)
617-496-1708 (Fax)

HOME PAGE: http://www.economics.harvard.edu/~ashleife/

National Bureau of Economic Research (NBER)

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United States

European Corporate Governance Institute (ECGI)

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1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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