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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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    Cited by:

    1. Cassella, Stefano & Chen, Te-Feng & Gulen, Huseyin & Liu, Yan, 2025. "Extracting extrapolative beliefs from market prices: An augmented present-value approach," Journal of Financial Economics, Elsevier, vol. 164(C).
    2. Beckmeyer, Heiner & Meyerhof, Paul, 2025. "The short-duration premium and news announcements," Journal of Banking & Finance, Elsevier, vol. 176(C).
    3. Boehl, Gregor & Hommes, Cars, 2025. "Rational vs. irrational beliefs in a complex world," Journal of Economic Behavior & Organization, Elsevier, vol. 232(C).
    4. Perino, Grischa, 2024. "Carbon market design and market sentiment," Journal of Environmental Economics and Management, Elsevier, vol. 128(C).
    5. Johnson, William C., 2025. "Valuing cryptocurrencies: A model of price and hashrate," Finance Research Letters, Elsevier, vol. 86(PA).
    6. Stefan Nagel, 2026. "Experiences, expectations, and asset prices," Journal of Business Economics, Springer, vol. 96(1), pages 11-34, January.
    7. Lin, Wenlian & Cao, Jerry & Li, Yong, 2025. "Risk concerns and market liquidity: A regression discontinuity design," Journal of Financial Markets, Elsevier, vol. 76(C).
    8. Dahlquist, Magnus & Ibert, Markus, 2026. "Institutions’ return expectations across assets and time," Journal of Financial Economics, Elsevier, vol. 175(C).
    9. Cassella, Stefano & Chen, Te-Feng & Gulen, Huseyin & Liu, Yan, 2025. "Extracting extrapolative beliefs from market prices : An augmented present-value approac," Other publications TiSEM a19ca154-f344-4cd5-b2e5-c, Tilburg University, School of Economics and Management.
    10. Sophia Zhengzi Li & Zeyao Luan, 2025. "News-based investor disagreement and stock returns," Review of Accounting Studies, Springer, vol. 30(3), pages 2312-2375, September.
    11. Er, Selahattin Tolga & Kantorowicz, Jaroslaw, 2025. "Financial market reaction to the end of the right-wing populist government: The case of Poland," Finance Research Letters, Elsevier, vol. 76(C).
    12. Han, Leyla Jianyu, 2025. "Announcements, expectations, and stock returns with asymmetric information," Journal of Monetary Economics, Elsevier, vol. 151(C).
    13. Chaudhry, Aditya, 2025. "The impact of prices on analyst cash flow expectations: Reconciling subjective beliefs data with rational discount rate variation," Journal of Financial Economics, Elsevier, vol. 171(C).
    14. Namrata Narain & Namrata Narain, 2026. "The Market Impact of Fed Communications: The Role of the Press Conference," International Journal of Central Banking, International Journal of Central Banking, vol. 22(1), pages 313-389, January.
    15. Giuseppe Matera, 2025. "Corporate Earnings Calls and Analyst Beliefs," Papers 2511.15214, arXiv.org, revised Nov 2025.
    16. Fontanier, Paul, 2025. "Optimal policy for behavioral financial crises," Journal of Financial Economics, Elsevier, vol. 166(C).
    17. Bro, Jeppe & Eriksen, Jonas N., 2025. "Subjective expectations and house prices," Journal of Banking & Finance, Elsevier, vol. 172(C).
    18. Bordalo, Pedro & Gennaioli, Nicola & La Porta, Rafael & Shleifer, Andrei, 2025. "Finance without exotic risk," Journal of Financial Economics, Elsevier, vol. 173(C).
    19. Xu, Hangtian & Zheng, Wenzhuo, 2024. "Growth-driven shantytown redevelopment and housing market dynamics in the low-tier cities of China," MPRA Paper 124326, University Library of Munich, Germany.
    20. Kevin Benson & Ing-Haw Cheng & John Hull & Charles Martineau & Yoshio Nozawa & Vasily Strela & Yuntao Wu & Jun Yuan, 2024. "Understanding the Excess Bond Premium," Papers 2412.04063, arXiv.org.

    More about this item

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G4 - Financial Economics - - Behavioral Finance

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