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New evidence on the effect of belief heterogeneity on stock returns

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Abstract

We develop a new measure to examine the effect of the heterogeneity of beliefs among investors on stock returns. Our initial results do not support the information asymmetry hypothesis or the sidelined investor hypothesis (and thus are consistent with the unbiased prices hypothesis). However, since the first two hypotheses make opposite predictions regarding stock returns, they may both have merit but offset one another. Further analysis suggests that this is indeed the case. Overall, our results support both the information asymmetry and sidelined investor hypotheses and thus occupy middle ground in the debate on the effect of disagreement on stock returns.

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Notes

  1. Chen and Guo (2010) apply a version of Miller (1977) model in IPO settings to study many IPO related patterns.

  2. For the purposes of this paper, it is immaterial if the number of buyers is greater than the number of sellers or vice versa. This is because we are concerned about the difference in opinion among traders rather than their actual preferences with respect to buying or selling. In addition, the use of absolute values aids the analysis in the next section.

  3. We agree with the argument that stronger belief in a private signal will manifest itself in more buying or selling by an institution. Thus, the number of shares bought or sold may provide additional information. We believe our simpler measure performs as well and has the additional benefit that it helps us focus on the more fundamental issue of disagreement by removing the effect of greater dollar holdings by an institution.

  4. We also used a more liberal 10 % increase to proxy for seasoned equity offerings. This does not materially affect our results.

  5. Additionally, we reproduced Tables 2, 3, 4, 5 and included the abnormal returns for months 4, 5, and 6 as well as months 1, 2, and 3. The results remained unchanged. For the sake of brevity we do not report the results for months 4, 5 and 6 in this paper.

  6. We also conducted various dependent sorts on firm size and institutional ownership. The results we obtained were very similar to those of the two independent sorts reported in Table 5.

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Authors and Affiliations

  1. Department of Finance, Banking and Insurance, Walker College of Business, Appalachian State University, Boone, NC, USA

    Jeffrey Hobbs

  2. Department of Accounting and Finance, University of Michigan-Dearborn, Dearborn, MI, USA

    Hei Wai Lee & Vivek Singh

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  1. Jeffrey Hobbs
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  2. Hei Wai Lee
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  3. Vivek Singh
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Correspondence to Vivek Singh.

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Hobbs, J., Lee, H.W. & Singh, V. New evidence on the effect of belief heterogeneity on stock returns. Rev Quant Finan Acc 48, 289–309 (2017). https://doi.org/10.1007/s11156-016-0551-7

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