Correlated Beliefs, Returns, and Stock Market Volatility
Firm-level stock returns exhibit comovement above that in fundamentals, and the gap tends to be higher in developing countries. We investigate whether correlated beliefs among sophisticated, but imperfectly informed, traders can account for the patterns of return correlations across countries. We take a unique approach by turning to direct data on market participants’ information - namely, real-time firm-level earnings forecasts made by equity market analysts. The correlations of firm-level forecasts exceed those of fundamentals and are strongly related to return correlations across countries. A calibrated information-based model demonstrates that the correlation of beliefs implied by analyst forecasts leads to return correlations broadly in line with the data, both in levels and across countries - the correlation between predicted and actual is 0.63. Our findings have implications for market-wide volatility - the model-implied correlations alone can explain 44% of the cross-section of aggregate volatility. The results are robust to controlling for a number of alternative factors put forth by the existing literature.
We thank Kamil Yilmaz for an insightful discussion, seminar participants at UC Davis and NBER ISoM for their comments and suggestions, and Venky Venkateswaran for useful conversations. We thank Luca Macedoni for his research assistance. Ina Simonovska acknowledges financial support from the Hellman Fellowship Program and the Institute of Social Sciences at UC Davis. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Joel M. David & Ina Simonovska, 2015. "Correlated beliefs, returns, and stock market volatility," Journal of International Economics, vol (). citation courtesy of
Correlated Beliefs, Returns, and Stock Market Volatility, Joel M. David, Ina Simonovska. in NBER International Seminar on Macroeconomics 2015, Devereux, Giavazzi, and West. 2016