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Cross-Sectional Dispersion of Firm Valuations and Expected Stock Returns

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  • Jiang, Danling

Abstract

This paper develops two competing hypotheses for the relation between the cross-sectional standard deviation of logarithmic firm fundamental-to-price ratios (``dispersion'') and expected aggregate returns. In models with fully rational beliefs, greater dispersion indicates greater risk and higher expected aggregate returns. In models with investor overconfidence, greater dispersion indicates greater mispricing and lower expected aggregate returns. Consistent with the behavioral models, the results show that (1) measures of dispersion are negatively related to subsequent market excess returns, (2) this negative relation is more pronounced among riskier firms, and (3) dispersion is positively related to aggregate trading volume, idiosyncratic volatility, and investor sentiment, and increases after good past market performance.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 8325.

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Date of creation: 18 Apr 2008
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Handle: RePEc:pra:mprapa:8325

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Keywords: Return predictability; Dispersion; Overconfidence; Idiosyncratic volatility; Investor sentiment;

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Cited by:
  1. Costas Azariadis & Leo Kaas, 2012. "Self-Fulfilling Credit Cycles," Working Paper Series of the Department of Economics, University of Konstanz 2012-16, Department of Economics, University of Konstanz.
  2. Jorgensen, Bjorn & Li, Jing & Sadka, Gil, 2012. "Earnings dispersion and aggregate stock returns," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 53(1), pages 1-20.
  3. Tracy Yue Wang & David Hirshleifer & Bing Han, 2010. "Investor Overconfidence and the Forward Discount Puzzle," 2010 Meeting Papers, Society for Economic Dynamics 1201, Society for Economic Dynamics.

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