Extrapolation Bias and Short-Horizon Return Predictability

77 Pages Posted: 9 Mar 2021 Last revised: 7 May 2024

See all articles by Huseyin Gulen

Huseyin Gulen

Mitchell E. Daniels, Jr School of Business, Purdue University; Purdue University - Krannert School of Management

Michael Woeppel

Indiana University - Kelley School of Business - Department of Finance

Date Written: May 7, 2024

Abstract

Using survey data, we show that investor expectations of short-horizon aggregate returns are extrapolative and negatively related to future short-horizon aggregate returns. To assess the role of extrapolative expectations in short-horizon return predictability at both the aggregate and firm levels, we develop a proxy for the extrapolative component of expectations. Our extrapolation proxy, which can be calculated for all firms and time periods, has significant short-horizon return predictive power at both the aggregate and firm levels. Overall, our results support extrapolation-based theories and suggest that short-horizon return predictability is better understood when considering the possibility of short-horizon return extrapolation.

Keywords: Extrapolative expectations, overextrapolation, short-horizon return predictability

JEL Classification: G02, G12, G15

Suggested Citation

Gulen, Huseyin and Woeppel, Michael, Extrapolation Bias and Short-Horizon Return Predictability (May 7, 2024). Kelley School of Business Research Paper No. 2021-09, Available at SSRN: https://ssrn.com/abstract=3800419 or http://dx.doi.org/10.2139/ssrn.3800419

Huseyin Gulen

Mitchell E. Daniels, Jr School of Business, Purdue University ( email )

403 Mitch Daniels Blvd.
West Lafayette, IN 47907
United States

Purdue University - Krannert School of Management ( email )

1310 Krannert Building
West Lafayette, IN 47907-1310
United States

Michael Woeppel (Contact Author)

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

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