Differences of Opinion Predict Volatility

29 Pages Posted: 12 Jul 2021

Date Written: July 8, 2021

Abstract

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

Jensen, Christian Skov and Jensen, Mads Vestergaard, Differences of Opinion Predict Volatility (July 8, 2021). Available at SSRN: https://ssrn.com/abstract=3882792 or http://dx.doi.org/10.2139/ssrn.3882792

Christian Skov Jensen (Contact Author)

Bocconi University ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Mads Vestergaard Jensen

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

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