• "Divergence of Opinion and the Cross Section of Stock Returns" (Job Market Paper)
  • Abstract:  In this paper we generalize Tauchen and Pitts' (1983) well-known Mixture of Distribution Hypothesis (MDH), which links asset volume and volatility in a way that derives a proxy for divergence of opinion among all individual investors. This new measure is a more reliable proxy for divergence of opinion among all individual investors than the existing proxies such as dispersion in analysts' earnings forecasts and turnover. We then use this measure of divergence of opinion in an empirical asset pricing analysis. In particular, we incorporate the crucial role of divergence of opinion in the determination of cross-sectional asset returns, establishing that when divergence of opinion is high, stock prices tend to be biased upward, resulting in lower future returns. These effects are especially pronounced for small, low-book-to-market, and high-momentum stocks, which are more difficult and costly to short sell. Hence the evidence for these stocks supports Miller's (1977) view that, given short-sale constraints, observed prices overweight optimistic valuations. The predictions of recent theoretical work, such as Hong and Stein (2003), are valid only for stocks that are easier to short sell.

 Publications

• "A Framework for Exploring the Macroeconomic Determinants of Systematic Risk," American Economic Review, May 2005, Forthcoming.  With T. Andersen, T. Bollerslev and F. Diebold.
• "Realized Beta: Persistence and Predictability," in T. Fomby (ed.) Advances in Econometrics: Econometric Analysis of Economic and Financial Time Series, Volume B, 2005, forthcoming. With T. Andersen, T. Bollerslev and F. Diebold.
   
  • Abstract: A large literature over several decades reveals both extensive concern with the question of time-varying betas and an emerging consensus that betas are in fact time-varying, leading to the prominence of the conditional CAPM. Set against that background, we assess the dynamics in realized betas, vis-à-vis the dynamics in the underlying realized market variance and individual equity covariances with the market. Working in the recently-popularized framework of realized volatility, we are led to a framework of nonlinear fractional cointegration: although realized variances and covariances are very highly persistent and well approximated as fractionally-integrated, realized betas, which are simple nonlinear functions of those realized variances and covariances, are less persistent and arguably best modeled as stationary I(0) processes. We conclude by drawing implications for asset pricing and portfolio management.

 Work In Progress

•   “Macroeconomic Fundamentals and Time-Varying Betas,” with Andersen, T.G., Bollerslev, T., and Diebold, F.X.

•   “Divergence of Opinion and Negative Asymmetries in  Returns“
•   “Varieties of Capital Flight,” with Abiad, A. and Mody, A.