Extracting Extrapolative Beliefs from Market Prices: An Augmented Present-Value Approach

64 Pages Posted: 18 May 2021 Last revised: 21 Aug 2023

See all articles by Stefano Cassella

Stefano Cassella

Tilburg University- School of Economics and Management

Te-Feng Chen

Hong Kong Polytechnic University

Huseyin Gulen

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

Yan Liu

Purdue University

Date Written: August 20, 2023

Abstract

We propose a latent-variables approach to recover extrapolative beliefs from asset prices.
We estimate a present-value model of the price-dividend ratio of the market that embeds both return extrapolation and cash-flow extrapolation, alongside discount rates and rational expectations of dividend growth. This approach allows us to measure extrapolation bias without having to rely on survey data, and it inherently guarantees that the researcher focuses on a set of beliefs that matter for price formation. We show that extrapolative beliefs extracted from prices are highly correlated with surveys, and that survey-based and price-based extrapolative beliefs share similar predictive properties for future returns, with the former improving upon the latter.

Keywords: Present value, Structural estimation, Expectations, Extrapolation bias, Behavioral, Sentiment, Predictive regression, Discount rate, Dividend growth

JEL Classification: G12, G17, G41

Suggested Citation

Cassella, Stefano and Chen, Te-Feng and Gulen, Huseyin and Liu, Yan, Extracting Extrapolative Beliefs from Market Prices: An Augmented Present-Value Approach (August 20, 2023). Available at SSRN: https://ssrn.com/abstract=3847527 or http://dx.doi.org/10.2139/ssrn.3847527

Stefano Cassella

Tilburg University- School of Economics and Management ( email )

Professor de Moorplein 521
Tilburg, 5037
Netherlands

Te-Feng Chen

Hong Kong Polytechnic University ( email )

Hung Hom, Kowloon
Hong Kong
+852 3400 3856 (Phone)

Huseyin Gulen (Contact Author)

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

Yan Liu

Purdue University ( email )

West Lafayette, IN 47907-1310
United States

HOME PAGE: http://yliu1.com

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