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Asper professor Lei Lu wearing a black suit and tie, smiling with glasses on.

Individual investors’ dispersion in beliefs and stock returns

Asper Professor Lei Lu co-authors paper published in Financial Management

March 4, 2022 — 

Investors’ beliefs are central to asset pricing, since different beliefs about firms’ fundamentals affect both stock prices and dynamics. However, not all investors are the same — individual investors may have limited information or knowledge compared with institutional ones, and therefore, their opinions cannot represent all investors. The information conveyed by financial analysts, too, is sometimes subject to bias.

These findings by Dr. Lei Lu, Bryce Douglas Chair in Finance and Professor of Finance at the Asper School of Business and co-authors Junjun Ma, Xindan Li, Weixing Wu and Xiong Xiong were recently published in Financial Management (FM), an Association of Business Schools Level 3 Journal. FM publishes original high quality research papers aimed at serving both academics and practitioners in the broad field of finance.

In their work titled Individual investors’ dispersion in beliefs and stock returns, Lu, Ma, Li, Wu and Xiong indicate that the paper constructs a new measure of investors’ differences in beliefs using the individual trading data from daily and weekly frequencies, examining its effects on stock return, stock volatility, and trading volume when the market has frictions (i.e., illiquidity, sentiment, gambling, and short-sale constraints) or investors are not rational (e.g., gambling), and explores whether investors’ characteristics (i.e., age, education, gender, wealth, and investment experience) influence their different beliefs.

It also finds that dispersion in beliefs among individual investors is significantly related to these characteristics, even when controlling firms’ fundamentals. Specifically, stocks with more wealthy, younger, and male investors tend to have higher belief dispersion. Conversely, stocks with more experienced investors have lower dispersion in beliefs.

Professor Lu noted that this research strengthens his understanding of individual investors’ trading behaviour and its impacts on financial markets.

“Investors have different opinions about firms’ fundamentals (i.e., dividend) and macroeconomics (i.e., GDP growth or inflation), and then differ in their trading behavior when selecting stocks and changing portfolios,” says Lu. “The larger the dispersion in beliefs among individual investors, the lower the expected return the stock will have. Moreover, this negative disagreement-return relationship is affected by stock liquidity, investors’ gambling behavior, and market sentiment. Individual investors need consider these factors when making decisions in financial investment.”

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