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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.

Suggested Citation

  • Jiang, Danling, 2008. "Cross-Sectional Dispersion of Firm Valuations and Expected Stock Returns," MPRA Paper 8325, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:8325
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    File URL: https://mpra.ub.uni-muenchen.de/8325/1/MPRA_paper_8325.pdf
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    References listed on IDEAS

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    Cited by:

    1. Costas Azariadis & Leo Kaas & Yi Wen, 2016. "Self-Fulfilling Credit Cycles," Review of Economic Studies, Oxford University Press, vol. 83(4), pages 1364-1405.
    2. Han, Bing & Hirshleifer, David & Wang, Tracy Yue, 2005. "Investor Overconfidence and the Forward Discount Puzzle," Working Paper Series 2005-21, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    3. Jorgensen, Bjorn & Li, Jing & Sadka, Gil, 2012. "Earnings dispersion and aggregate stock returns," Journal of Accounting and Economics, Elsevier, vol. 53(1), pages 1-20.
    4. Chang, Eric C. & Luo, Yan & Ren, Jinjuan, 2013. "Pricing deviation, misvaluation comovement, and macroeconomic conditions," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 5285-5299.

    More about this item

    Keywords

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

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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