Heterogeneous Beliefs and Stock Market Fluctuations

55 Pages Posted: 18 Oct 2021 Last revised: 18 Nov 2022

See all articles by Odhrain McCarthy

Odhrain McCarthy

New York University (NYU) - Department of Economics

Sebastian Hillenbrand

Harvard University - Business School (HBS)

Date Written: October 18, 2021


Stock prices aggregate the beliefs of different investors. Using this insight, we estimate the fraction of stock market investors holding survey beliefs. We find that 42% of investors hold beliefs matching those of equity analysts and 25% hold beliefs as observed in individual investor return surveys. Together with risk aversion proxies and rational cash flow forecasts constructed using machine learning techniques, survey beliefs explain 87% of stock market fluctuations. Because investors likely form their beliefs by extrapolating prices and cash flows, we find stock prices would fluctuate 50% less if all investors held rational beliefs. Allowing for investor heterogeneity and using a price driven price-to-earnings ratio reconciles prior studies.

Keywords: Heterogeneous beliefs, extrapolative expectations, stock market valuation, asset pricing, survey expectations, price decomposition

JEL Classification: G11, G12, G4

Suggested Citation

McCarthy, Odhrain and Hillenbrand, Sebastian, Heterogeneous Beliefs and Stock Market Fluctuations (October 18, 2021). Available at SSRN: https://ssrn.com/abstract=3944887 or http://dx.doi.org/10.2139/ssrn.3944887

Odhrain McCarthy

New York University (NYU) - Department of Economics ( email )

Bobst Library, E-resource Acquisitions
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New York, NY 10003-711
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Sebastian Hillenbrand (Contact Author)

Harvard University - Business School (HBS) ( email )

Boston, MA 02163
United States

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