Essays in Asset Pricing with Extrapolative Beliefs and Short-Selling

Fangcheng Ruan, Purdue University

Abstract

In the first chapter, we developed a dynamic equilibrium model of multiple stocks with extrapolators under the framework of Barberis, Greenwood, Jin, and Shleifer (2015a). Our model builds on the fact that extrapolative investors assign different relative weights of recent versus distant past return when forming their beliefs. We find that stock price increases in its own past performance measure, and is additionally associated with the past performance measure of the other stock if their dividends are correlated. The stock with higher relative weight have higher stock price, higher stock volatility, and lower risk premium. Both the own stock’s and the other stock’s past performance measure negatively predicts future stock price changes. The second chapter includes Adem Atmaz, Stefano Cassella, and Huseyin Gulen as co-authors. In this chapter, we document considerable cross-sectional variation in survey expectations about aggregate stock market returns. While most investors are extrapolators who expect higher returns after a good market performance, some are contrarians who expect lower returns after a good performance. More notably, compared to extrapolators, contrarians have less persistent expectations that are corrected more quickly. Accordingly, we develop a dynamic equilibrium model accounting for these differences in expectations and find that the equilibrium stock price exhibits short-term momentum and long-term reversal as in the data. Furthermore, we test the key predictions of the model linking the shortterm momentum to observable differences between extrapolators and contrarians and find supportive evidence for our mechanism. The third chapter includes Adem Atmaz and Suleyman Basak as co-authors. In this chapter, we develop a dynamic model of costly stock short-selling and lending market and obtain implications simultaneously supporting many empirical regularities. In our model, investors’ belief disagreement leads to lenders and short-sellers, who pay shorting fees to borrow stocks from lenders. Our main novel results are as follows. Short interest predicts future stock returns negatively and has a stronger predictive power than the corresponding dividend-price ratio. Higher short-selling risk can be associated with lower stock returns and less short-selling activity. Stock volatility is increased under costly short-selling. An application to the GameStop episode yields implications consistent with observed patterns.

Degree

Ph.D.

Advisors

Atmaz, Purdue University.

Subject Area

Finance

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