Asset Prices When Investors Ignore Discount Rate Dynamics

63 Pages Posted: 11 Jan 2021 Last revised: 18 Jun 2021

Date Written: September 21, 2020

Abstract

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

Renxuan, Wang, Asset Prices When Investors Ignore Discount Rate Dynamics (September 21, 2020). Available at SSRN: https://ssrn.com/abstract=3740790 or http://dx.doi.org/10.2139/ssrn.3740790

Wang Renxuan (Contact Author)

CEIBS ( email )

Shanghai-Hongfeng Road
Shanghai 201206
Shanghai 201206
China

HOME PAGE: http://www.ceibs.edu/wang_renxuan

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