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

90 Pages Posted: 28 Nov 2021 Last revised: 16 Aug 2022

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 firm mispricing (overvaluation). Analyst forecast errors are particularly increased when REG provides confirming information. In turn, REG is positively predicted by analyst forecast errors and higher mispricing, leading to a continuation of firm overvaluation over several quarters. 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. A simple structural model explains the predictive power of REG for analyst forecast errors and the build-up of mispricing by incorporating the dynamic expectation formation between
different agents.

Keywords: Investor beliefs, analysts, mispricing, misreaction

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

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
254
Abstract Views
1,086
rank
176,383
PlumX Metrics