The Cross-section of Subjective Expectations: Understanding Prices and Anomalies

Abstract

We decompose cross-sectional differences in the level of price-earnings ratios using professional forecasts. High price-earnings ratios are accounted for by both low expected returns and overly high expected earnings growth. The magnitudes and timing of the comovements between prices, earnings growth, and returns are consistent with gradual learning rather than expectations being highly sensitive to recent realizations. Earnings growth surprises do not translate 1-1 into one-period returns, but instead are gradually reflected in returns over time. A structural risk-premia model incorporating constant-gain learning about mean earnings growth replicates our findings and generates realistic dispersion and persistence in price-earnings ratios.

Keywords: subjective expectation, price dispersion, learning, mispricing, revisions