Heterogeneous Beliefs and Stock Market Fluctuations
55 Pages Posted: 18 Oct 2021 Last revised: 18 Nov 2022
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: Suggested Citation