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Belief Overreaction and Stock Market Puzzles

Author

Listed:
  • Pedro Bordalo
  • Nicola Gennaioli
  • Rafael La Porta
  • Andrei Shleifer

Abstract

We construct an index of long-term expected earnings growth for S&P 500 firms and show that it has remarkable power to jointly predict future errors in expectations and stock returns, in both the aggregate market and the cross section. The evidence supports a mechanism whereby good news causes investors to become too optimistic about long-term earnings growth. This leads to inflated stock prices and, as beliefs are systematically disappointed, subsequent low returns in the aggregate market. Overreaction of long-term expectations helps resolve major asset-pricing puzzles without time-series or cross-sectional variation in required returns.

Suggested Citation

  • Pedro Bordalo & Nicola Gennaioli & Rafael La Porta & Andrei Shleifer, 2024. "Belief Overreaction and Stock Market Puzzles," Journal of Political Economy, University of Chicago Press, vol. 132(5), pages 1450-1484.
    • Handle: RePEc:ucp:jpolec:doi:10.1086/727713
    DOI: 10.1086/727713
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