Journal of Finance Vol. 59 No. 5 2004
Forecast Dispersion and the Cross Section of Expected Returns
Abstract
Recent work by Diether, Malloy, and Scherbina (2002) has established a negative relationship between stock returns and the dispersion of analysts' earnings forecasts. I offer a simple explanation for this phenomenon based on the interpretation of dispersion as a proxy for unpriced information risk arising when asset values are unobservable. The relationship then follows from a general options‐pricing result: For a levered firm, expected returns should always decrease with the level of idiosyncratic asset risk. This story is formalized with a straightforward model. Reasonable parameter values produce large effects, and the theory's main empirical prediction is supported in cross‐sectional tests.
- DOI
- 10.1111/j.1540-6261.2004.00688.x
- Volume
- 59
- Issue
- 5
- Pages
- 1957-1978
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref