Diagnostic Expectations and Stock Returns

2019/07/06 by Pedro Bordalo, PEDRO BORDALO, Nicola Gennaioli +4 · 412 citations
Decision Sciences · Economics, Econometrics and Finance · Mathematics · #Complex Systems and Time Series Analysis #Earnings #Earnings growth #Econometrics #Economics #Finance #Financial Markets and Investment Strategies #Financial economics #Geography #Mathematics #Pessimism #Representativeness heuristic #Statistics #Stock (firearms) #Stock Market Forecasting Methods

paper · doi:10.1111/jofi.12833

published in The Journal of Finance 74(6), 2839-2874 (Wiley)

openalex publication_date 2019/07/06 · openalex created_date 2025/10/10 · openalex updated_date 2026/08/04

Abstract

ABSTRACT 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.

Citations

• Subjective probability: A judgment of representativeness
• Information Rigidity and the Expectations Formation Process: A Simple Framework and New Facts

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• Overreaction in Macroeconomic Expectations
• Game on: Social networks and markets
• The nominal share price anchor: A theoretical model of social norms and behavioral martingales in stock markets
• The Role of Intangible Investment in Predicting Stock Returns: Six Decades of Evidence

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