Asset Prices When Investors Ignore Discount Rate Dynamics
63 Pages Posted: 11 Jan 2021 Last revised: 26 Oct 2022
Date Written: September 21, 2020
I propose and test a unifying hypothesis to explain both cross-sectional return anomalies and subjective return expectation errors: some investors ignore discount rate dynamics when forming return expectations. Consistent with the hypothesis: (1) stocks' expected cash flow growth and idiosyncratic volatility explain the significant cross-sectional variation of analysts' return forecast errors; (2) a measure of mispricing at the firm level strongly predicts stock returns, even among stocks in the S&P 500 universe and at long horizons; (3) a tradable mispricing factor explains the CAPM alphas of 12 leading anomalies including investment, profitability, beta, idiosyncratic volatility, and cash flow duration.
Keywords: Asset Pricing, Biased Expectation, Valuation, Cross-Sectional Anomalies, Expectation Formation, Mispricing, Constant Discount Rate
JEL Classification: G1, G4
Suggested Citation: Suggested Citation