Macro Disagreement and the Cross-Section of Stock Returns

Frank Weikai Li
2015 Review of Asset Pricing Studies  
This paper examines the effects of macro-level disagreement on the cross-section of stock returns. Using forecast dispersion measures from the Survey of Professional Forecasters database as proxies for macro disagreement, I find that high macro beta stocks earn lower future returns relative to low macro beta stocks following high macro disagreement states. This negative relation between returns for macro factors and macro disagreement is robust and exists for a large set of macroeconomic
more » ... acroeconomic factors, suggesting that high macro beta stocks are overvalued compared with low macro beta stocks due to their greater sensitivity to aggregate disagreement. (JEL G02, G12) This paper studies how investors' dispersion of beliefs about certain important macroeconomic variables affects prices in the cross-section of stocks. Asset pricing theories posit that pervasive macroeconomic factors should be systematic risk factors that are priced in equilibrium. For example, in the Merton (1973) intertemporal capital asset pricing model (ICAPM), expected stock returns are determined by their return covariance with innovation in state variables that reflect time-varying investment opportunities. Macroeconomic factors (such as industrial production growth and expected inflation) naturally serve as a proxy for such state variables. The consumption-based asset pricing model predicts that an asset's return covariance with consumption growth rate determines its riskiness and hence expected return (Breeden 1979) . Even the Sharpe-Lintner capital asset pricing model (CAPM) (Sharpe 1964; Lintner 1965) can be viewed in some way as a macro factorbased asset pricing model, in which the only state variable is the return on the market portfolio. Despite the theoretical importance of macroeconomic risk factors in explaining the cross-section of expected asset returns, empirical evidence I am deeply indebted to the editor,Wayne Ferson, an anonymous referee, Harrison Hong, and Jialin Yu for suggestions that have substantially improved the paper. I also thank
doi:10.1093/rapstu/rav008 fatcat:5rccoh2xjjeatpqw5nvq6hu2hi