Harrison and Kreps (1978) and Scheinkman and Xiong (2003) argue
that in a dynamic setting, a second, speculation-based mechanism arises.
They show that when there are differences in beliefs, investors will be
happy to buy a stock for more than its fundamental value in anticipation of
being able to sell it later to other investors even more optimistic than them-
selves. Note that short-sale constraints are essential to this story: in their
absence, an investor can profit from another’s greater optimism by simply
shorting the stock. With short-sale constraints, the only way to do so is to
buy the stock first, and then sell it on later.
Both types of models make the intriguing prediction that stocks which
investors disagree about more will have higher price/earnings ratios and
lower subsequent returns. Three recent papers test this prediction, each using
a different measure of differences of opinion.
Diether, Malloy, and Scherbina (2002) use IBES data on analyst forecasts
to obtain a direct measure of heterogeneity of opinion. They group stocks
into quintiles based on the level of dispersion in analysts’ forecasts of cur-
rent year earnings and confirm that the highest dispersion portfolio earns
lower average returns than the lowest dispersion portfolio.
Chen, Hong, and Stein (2002) use “breadth of ownership”—defined
roughly as the fraction of mutual funds that hold a particular stock—as a
proxy for divergence of opinion about the stock. The more dispersion in
opinions there is, the more mutual funds will need to sit out the market due
to short sales constraints, leading to lower breadth. Chen et al. predict, and
confirm in the data, that stocks experiencing a decrease in breadth subse-
quently have lower average returns compared to stocks whose breadth in-
creases.
Jones and Lamont (2002) use the cost of short-selling a stock—in other
words, the lending fee—to measure differences of opinion about that stock.
The idea is that if there is a lot of disagreement about a stock’s prospects,
many investors will want to short the stock, thereby pushing up the cost of
doing so. Jones and Lamont confirm that stocks with higher lending fees
have higher price/earnings ratios and earn lower subsequent returns. It is
interesting to note that their data set spans the years from 1926 to 1933. At
that time, there existed a centralized market for borrowing stocks and lend-
ing fees were published daily in The Wall Street Journal. Today, by con-
trast, stock lending is an over-the-counter market, and data on lending fees
is harder to come by.
In other related work, Hong and Stein (2003) show that short-sale con-
straints and differences of opinion also have implications for higher order
moments, in that they can lead to skewness. The intuition is that when a
stock’s price goes down, more information is revealed: by seeing at what
point they enter the market, we learn the valuations of those investors
whose pessimistic views could not initially be reflected in the stock price, be-
cause of short-sale constraints. When the stock market goes up, the sidelined
A SURVEY OF BEHAVIORAL FINANCE 45