Disagreement in Economic Forecasts and Equity Returns: Risk or Mispricing?

67 Pages Posted: 12 Mar 2014 Last revised: 3 Feb 2020

See all articles by Turan G. Bali

Turan G. Bali

Georgetown University - Robert Emmett McDonough School of Business

Stephen J. Brown

New York University - Stern School of Business

Yi Tang

Fordham University - Gabelli School of Business

Date Written: August 1, 2019

Abstract

We quantify disagreement about the economy with ex-ante measures of divergence of opinion among economic forecasters and investigate if economic disagreement has a significant impact on the cross-sectional pricing of individual stocks. We find a significant disagreement premium of 7.2% per annum, induced by both outperformance of stocks with negative disagreement beta and underperformance of stocks with positive disagreement beta. We show that in the sample of undervalued (overvalued) stocks, those with negative (positive) disagreement beta are most undervalued (overvalued) in the portfolio formation month and hence earn significantly positive (negative) alpha. Disagreement premium is also found to be weak in the sample of fairly priced stocks. Thus, our results support the mispricing and arbitrage risk hypotheses that the positive (negative) disagreement beta provides an indirect way to measure dispersed opinion and overpricing (underpricing).

Keywords: dispersion in economic forecasts, mispricing, disagreement risk, cross-section of stock returns, return predictability

JEL Classification: G11, G12, C13, E20, E30

Suggested Citation

Bali, Turan G. and Brown, Stephen J. and Tang, Yi, Disagreement in Economic Forecasts and Equity Returns: Risk or Mispricing? (August 1, 2019). Georgetown McDonough School of Business Research Paper No. 2407279, Available at SSRN: https://ssrn.com/abstract=2407279 or http://dx.doi.org/10.2139/ssrn.2407279

Turan G. Bali (Contact Author)

Georgetown University - Robert Emmett McDonough School of Business ( email )

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Washington, DC 20057
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HOME PAGE: https://sites.google.com/a/georgetown.edu/turan-bali

Stephen J. Brown

New York University - Stern School of Business ( email )

Stern School of Business
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United States
212-998-0306 (Phone)
212-995-4233 (Fax)

Yi Tang

Fordham University - Gabelli School of Business ( email )

113 West 60th Street
New York, NY 10023
United States

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