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Machine Forecast Disagreement

Author

Listed:
  • Turan G. Bali
  • Bryan T. Kelly
  • Mathis Mörke
  • Jamil Rahman

Abstract

We propose a statistical model of differences in beliefs in which heterogeneous investors are represented as different machine learning model specifications. Each investor forms return forecasts from their own specific model using data inputs that are available to all investors. We measure disagreement as dispersion in forecasts across investor-models. Our measure aligns with extant measures of disagreement (e.g., analyst forecast dispersion), but is a significantly stronger predictor of future returns. We document a large, significant, and highly robust negative cross-sectional relation between belief disagreement and future returns. A decile spread portfolio that is short stocks with high forecast disagreement and long stocks with low disagreement earns a value-weighted average return of 14% per year. A range of analyses suggest the alpha is mispricing induced by short-sale costs and limits-to-arbitrage.

Suggested Citation

  • Turan G. Bali & Bryan T. Kelly & Mathis Mörke & Jamil Rahman, 2023. "Machine Forecast Disagreement," NBER Working Papers 31583, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:31583
    Note: AP
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    More about this item

    JEL classification:

    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C4 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics
    • C45 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Neural Networks and Related Topics
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G1 - Financial Economics - - General Financial Markets
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G4 - Financial Economics - - Behavioral Finance
    • G40 - Financial Economics - - Behavioral Finance - - - General

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