Investor (Mis)Reaction, Biased Beliefs, and the Mispricing Cycle

90 Pages Posted: 28 Nov 2021 Last revised: 23 Jul 2023

See all articles by Azi Ben-Rephael

Azi Ben-Rephael

Rutgers Business School - Rutgers University

Steffen Hitzemann

University of Houston - Department of Finance

Yuanyuan Xiao

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick

Date Written: November 19, 2021

Abstract

We construct a new measure that captures the disparity between the market reaction to earnings information and the earnings surprise ("Return-Earnings Gap", "REG"). High REG positively predicts analyst forecast errors and a build-up of firm mispricing (overvaluation) over several quarters. Future analyst errors are particularly increased and accompanied by stronger mispricing when REG provides confirming information. A simple model for the dynamic expectation formation between different market participants corroborates these findings. Overall, our results reveal how the market’s (mis)reaction feeds back into the belief formation of analysts and investors, leading to a slow correction of firm mispricing.

Keywords: investor beliefs, analysts, analysts’ expectations, mispricing, misreaction, anomalies

JEL Classification: G00, G12, G14, G40, G41

Suggested Citation

Ben-Rephael, Azi and Hitzemann, Steffen and Xiao, Yuanyuan, Investor (Mis)Reaction, Biased Beliefs, and the Mispricing Cycle (November 19, 2021). Available at SSRN: https://ssrn.com/abstract=3966758 or http://dx.doi.org/10.2139/ssrn.3966758

Azi Ben-Rephael (Contact Author)

Rutgers Business School - Rutgers University ( email )

HOME PAGE: http://https://sites.google.com/site/abenreph

Steffen Hitzemann

University of Houston - Department of Finance ( email )

Houston, TX 77204
United States

Yuanyuan Xiao

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick ( email )

1 Washington Park
Newark, NJ 07102
United States

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