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Predictability concentrates in bad times. And so does disagreement

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Within a standard risk-based asset pricing framework with rational expectations, realized returns have two components: Predictable risk premiums and unpredictable shocks. In bad times, the price of risk increases. Hence, the predictable fraction of returns – and predictability – increases. “Disagreement” (dispersion in analyst forecasts) also intensifies in bad times if (i) analysts report (close to) risk-neutral expectations weighted by state prices, which become more volatile, or (ii) dividend volatility changes with the price of risk – for example, because consumption volatility changes. In both cases, individual analysts produce unbiased forecasts based on partial information.

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  • de Oliveira Souza, Thiago, 2019. "Predictability concentrates in bad times. And so does disagreement," Discussion Papers on Economics 8/2019, University of Southern Denmark, Department of Economics.
    • Handle: RePEc:hhs:sdueko:2019_008
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    1. de Oliveira Souza, Thiago, 2020. "Two out-of-sample forecasting models of the equity premium," Discussion Papers on Economics 11/2020, University of Southern Denmark, Department of Economics.

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    More about this item

    Keywords

    Predictability; bad times; efficient market hypothesis; disagreement; rational expectations;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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