Authors: Hong, Harrison; Stein, Jeremy C.

Source: The Journal of Economic Perspectives, Volume 21, Number 2, Spring 2007 , pp. 109-128(20)

Publisher: American Economic Association

Abstract:

A large catalog of variables with no apparent connection to risk has been shown to forecast stock returns, both in the time series and the cross-section. For instance, we see medium-term momentum and post-earnings drift in returns—the tendency for stocks that have had unusually high past returns or good earnings news to continue to deliver relatively strong returns over the subsequent six to twelve months (and vice-versa for stocks with low past returns or bad earnings news); we also see longer-run fundamental reversion—the tendency for "glamour" stocks with high ratios of market value to earnings, cashflows, or book value to deliver weak returns over the subsequent several years (and vice-versa for "value" stocks with low ratios of market value to fundamentals). To explain these patterns of predictability in stock returns, we advocate a particular class of heterogeneous-agent models that we call "disagreement models." Disagreement models may incorporate work on gradual information flow, limited attention, and heterogeneous priors, but all highlight the importance of differences in the beliefs of investors. Disagreement models hold the promise of delivering a comprehensive joint account of stock prices and trading volume—and some of the most interesting empirical patterns in the stock market are linked to volume.

Document Type: Research article

Publication date: 2007-03-01

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• The Journal of Economic Perspectives (JEP) attempts to fill a gap between the general interest press and most other academic economics journals. The journal aims to publish articles that will serve several goals: to synthesize and integrate lessons learned from active lines of economic research; to provide economic analysis of public policy issues; to encourage cross-fertilization of ideas among the fields of thinking; to offer readers an accessible source for state-of-the-art economic thinking; to suggest directions for future research; to provide insights and readings for classroom use; and to address issues relating to the economics profession.
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