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Two Essays on Asset Prices
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This dissertation consists of two chapters. The first chapter examines the role of growth options on stock return continuation. Growth options are both difficult to value and risky. Daniel, Hirshleifer and Subrahmanyam (1998) argue that higher momentum profits earned by high market-to-book firms stem from investorsâ higher overconfidence due to the difficulty of valuing growth options. Johnson (2002) and Sagi and Seasholes (2007) offer an alternative rational explanation wherein growth options cause a wider spread in risk and expected returns between winners and losers. This paper suggests that firm-specific uncertainty helps disentangle these two different explanations. Specifically, the rational explanation is at work among firms with low firm specific uncertainty. However, the evidence is in favor of the behavioral explanation for firms with high firm specific uncertainty. This is consistent with the notion that investors are more prone to behavioral biases in the presence of firm-specific uncertainty and the resulting mispricings are less likely to be arbitraged away. The second chapter examines how investors capitalize differences of opinion when disagreements are common knowledge. We conduct an event study of the market's reaction to analysts' dispersed earnings forecast revisions. We find that investors take differences of opinion into account and do not exhibit an optimism bias. Our findings indicate that the overpricing of stocks with high forecast dispersion is not due to investors' tendency to overweight optimistic expectations, but rather due to investor credulity regarding analysts' incentives. Our findings support the notion that assets may become mispriced when rational investors face structural uncertainties as proposed by Brav and Heaton (2002).
- Doctoral Dissertations