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Diagnostic Expectations and Stock Returns
Author(s) -
BORDALO PEDRO,
GENNAIOLI NICOLA,
PORTA RAFAEL LA,
SHLEIFER ANDREI
Publication year - 2019
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12833
Subject(s) - representativeness heuristic , economics , earnings , econometrics , stock (firearms) , pessimism , earnings growth , financial economics , finance , statistics , mathematics , geography , philosophy , archaeology , epistemology
We revisit La Porta's finding that returns on stocks with the most optimistic analyst long‐term earnings growth forecasts are lower than those on stocks with the most pessimistic forecasts. We document the joint dynamics of fundamentals, expectations, and returns of these portfolios, and explain the facts using a model of belief formation based on the representativeness heuristic. Analysts forecast fundamentals from observed earnings growth, but overreact to news by exaggerating the probability of states that have become more likely. We find support for the model's predictions. A quantitative estimation of the model accounts for the key patterns in the data.