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Extrapolative beliefs in the cross-section: What can we learn from the crowds?

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  • Da, Zhi
  • Huang, Xing
  • Jin, Lawrence J.

Abstract

Using novel data from a crowdsourcing platform for ranking stocks, we investigate how investors form expectations about stock returns over the next week. We find that investors extrapolate from stocks’ recent past returns, with more weight on more recent returns, especially when recent returns are negative, salient, or from a dispersed cross-section. Such extrapolative beliefs are stronger among nonprofessionals and large stocks. Moreover, consensus rankings negatively predict returns over the next week, more so among stocks with low institutional ownership and a high degree of extrapolation. A trading strategy that sorts stocks on investor beliefs generates an economically significant profit.

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  • Da, Zhi & Huang, Xing & Jin, Lawrence J., 2021. "Extrapolative beliefs in the cross-section: What can we learn from the crowds?," Journal of Financial Economics, Elsevier, vol. 140(1), pages 175-196.
    • Handle: RePEc:eee:jfinec:v:140:y:2021:i:1:p:175-196
    DOI: 10.1016/j.jfineco.2020.10.003
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    More about this item

    Keywords

    Return extrapolation; Beliefs in the cross-section; Expectation formation;
    All these keywords.

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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