The Efficient Horizon of Expectation and Stock Prices

60 Pages Posted: 27 Oct 2021

See all articles by Yingguang (Conson) Zhang

Yingguang (Conson) Zhang

Peking University - Department of Finance, Guanghua School of Management

Date Written: October 26, 2021

Abstract

Investors' expectations on firms' cash flow growth can be biased (e.g. Bordalo et al. (2019)), yet we know little about how these biases and their asset pricing implications vary with forecast horizons. In this paper, I show that extreme expectations at all horizons beyond the current period inversely forecast abnormal stock returns, but some with a delay --- extreme expectations at long-horizons persist until they reach the imminent horizon, causing persistent mispricing. Consistent with managers' expectation management altering the efficient expectation horizon, the pattern is stronger after Regulation-FD. A model based on ``natural expectation'' by Fuster et al. (2010) generates the short- and long-horizon forecast error dynamics that match the empirical patterns. Surprisingly, this extrapolative belief model also predicts underreaction.

Keywords: Expectation formation, stock return, extrapolation, underreaction

JEL Classification: G02, G11, G14

Suggested Citation

Zhang, Yingguang, The Efficient Horizon of Expectation and Stock Prices (October 26, 2021). Available at SSRN: https://ssrn.com/abstract=3950009 or http://dx.doi.org/10.2139/ssrn.3950009

Yingguang Zhang (Contact Author)

Peking University - Department of Finance, Guanghua School of Management ( email )

Beijing, Beijing 100871
China

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