Earnings Belief Risk and the Cross-Section of Stock Returns*

This paper examines whether the risk arising from stochastic fluctuations in the average belief of investors about future stock earnings is priced. We construct the earnings belief measure using analysts’ EPS forecasts and an EPS forecasting model, which primarily captures the subjective opinions of institutional investors and represents a random source of commonality. The average return on stocks with high exposure to earnings belief risk is 5.82%/year higher ⇤We thank Yakov Amihud, Tim Baldenius, Michael Brennan, Stephen Brown, Francois Degeorge, Jerome Detemple, Olivier Scaillet, Fabio Trojani, and Jeffrey Wurgler for helpful comments and discussions, as well as participants of the 2013 NFA Annual Conference and the finance seminar at Shanghai Jiao Tong University. The financial support of the Swiss National Science Foundation and the NCCR-Finrisk Project C1 “Credit Risk and Non-Standard Sources of Risk in Finance” is greatly acknowledged. All errors are ours. †Rajna Gibson Brandon is the Swiss Finance Institute (SFI) Chaired Professor of Finance at the Geneva Finance Research Institute, University of Geneva, Geneva, Switzerland. Email: rajna.gibson@unige.ch ‡Songtao Wang is Assistant Professor at the Antai College of Economics and Management, Shanghai Jiao Tong University, Shanghai, China. Email: wangsongtao@sjtu.edu.cn