Diagnostic Expectations and Stock Returns

By P. Bordalo, N. Gennaioli, R. La Porta, A. Shleifer. Journal of Finance, 2019

264 citations recorded by the source corpus.

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.

Subfields: Economics and Econometrics, Finance, Management Science and Operations Research

View Paper: https://www.semanticscholar.org/paper/6dfd62d061a3b7e0f1ac8bbdf6d7b4df61160eae

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Citations in the corpus

Overreaction in Macroeconomic Expectations (2018, unknown): “The model incorporates Kahneman and Tversky’s (1972) representativeness heuristic, formalized as in Gennaioli and Shleifer (2010) and Bordalo et al. (2016)—henceforth, BCGS, into a framework of learning from noisy private signals.”
IQ, Expectations, and Choice (2019, unknown): “They rationalize their findings in a model of diagnostic expectations along the lines of Bordalo et al. (2016), Bordalo et al. (2018), and Bordalo et al. (2017).”
Game On: Social Networks and Markets (2021, background): “Lastly, my paper is related to the emerging literature on expectation formation (see, Bordalo et al. (2019) and references therein).”
Racial Bias in Bail Decisions ⇤ (2018, unknown): “[19] Bordalo, Pedro, Nicola Gennaioli, Rafael La Porta, and Andrei Shleifer, “Diagnostic Expectations and Stock Returns,” NBER Working Paper No.”
Extrapolative beliefs in the cross-section: What can we learn from the crowds? (2020, unknown): “Bordalo et al. (2019) examine analyst expectations about earnings growth in the cross-section.”
Psychology-based Models of Asset Prices and Trading Volume (2018, methodology): “More recent models include Fuster et al. (2012), Choi and Mertens (2013), Alti and Tetlock (2014), Hirshleifer et al. (2015), and Bordalo et al. (2017, 2018a).16 Models of cash-flow extrapolation predict that the past growth in an asset’s fundamentals will be negatively related to the asset’s…”