Belief Skewness and the Stock Market

Description

Not all market practitioners hold the same beliefs about the future: some are optimistic and some pessimistic. While it might, for instance, come from the fact that they have access to different information, the resulting heterogeneity in investor beliefssignificantly impacts financial markets. These heterogeneous beliefs, which can be described in terms of statistical moments of the investor belief distribution, are well studied in the academic literature, and numerous works investigate how they affectstock returns, volatility, and trading volume. Among the main moments of investor belief heterogeneity–mean, standard deviation, and skewness–, most studies to date have focused on the second of these, which provides a measure of dispersion. However, despiteits importance, belief dispersion does not capture all relevant information on belief heterogeneity that market practitioners could exploit.In particular, there is a lack of knowledge about the impact of the asymmetry of investorn beliefs. This feature is captured by the third moment of the belief distribution: skewness. More precisely, in the context of belief heterogeneity, a positive skewnessmeans that few investors have very optimistic views on a stock’s expected future cashflows, whereas most have slightly pessimistic views. A negative skewness means the opposite is true. Because these two situations differ greatly but can still exhibit identical belief dispersion, it is most likely that considering belief skewness has important asset pricing implications. Empirically, data further shows that investor beliefs display timevarying skewness, which further highlights the importance of studying this additionalcomponent of heterogeneous beliefs.This project aims to fill this knowledge gap by theoretically and empirically examining the impact of belief skewness on stock returns, volatility, and trading volume. It also aims to assess how this impact interacts with the impact of the first and secondmoments of the investor belief distribution. To do so, I will develop a general equilibrium model that incorporates a skewed distribution of investor beliefs, derive its implications on the stock characteristics, and test the model using empirical data.My findings will have significant implications. First, I will provide a comprehensive understanding of the impact of belief skewness, thereby increasing academic knowledge of how financial markets work. Second, the findings will help market practitioners betterunderstand the impact of belief heterogeneity so that they can adapt their investment portfolios and trading strategies to achieve better financial performances