Optimists, pessimists and stock prices

Abstract

We review the academic findings from psychology and economics on disagreement, and specifically on the effect of disagreement on asset prices. We discuss measurement of disagreement, and how disagreement coupled with constraints on short selling can sideline pessimistic investors and result in overpricing. We review the literature on short selling in financial markets, paying particular attention to how and why some issues become "hard-to-borrow", what factors go into the determination of borrowing costs, and discuss the evolution of borrowing costs over the last several decades. We show how an examination of the prices and borrowing costs for constrained stocks can lead to an improved understanding of how disagreement in financial markets arises and is resolved, and finally discuss directions for future research.

Keywords: disagreement, share lending, short-selling, mispricing

JEL Classification: G02, G12