Differences of Opinion Predict Volatility
29 Pages Posted: 12 Jul 2021
Date Written: July 8, 2021
As a new test of models of differences of opinion, we study empirically how the shorting market interacts with the equity volatility. Consistent with theories of differences of opinion, a positive (negative) demand shift in the shorting market predicts higher (lower) future stock volatility: A positive demand shift predicts an increase in the next week's annualized volatility of 4.8 percentage points, which corresponds to a 10.9% increase relative to the average weekly annualized volatility. The effect remains after controlling for other proxies of differences of opinion such as bid-ask spreads and volume, suggesting that the shorting market is an important channel in which investors reveal divergence or convergence in their beliefs about the future trajectory of individual stocks.
Keywords: Differences of opinion, equity volatility, costs of shorting, short interest
JEL Classification: G00, G10, G12
Suggested Citation: Suggested Citation