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Market Reactions to Differences of Opinion

In this paper we find evidence that dispersion of opinion leads to systematic security overvaluation. Stocks with lower dispersion in analyst earnings forecasts earn remarkably higher future returns than otherwise similar stocks with higher dispersion. Further, we present evidence that this relation is not accounted for by the standard multifactor risk-based model of Fama and French (1993). Our sample of data covers seven European countries - the four Nordic countries Denmark, Finland, Norway and Sweden as well as the three economically dominant European countries France, Germany, and the U.K. Our research tests the robustness of Diether, Malloy, and Scherbina (2002) hypothesis of analyst dispersion as a proxy for differences of opinion among investors with non-U.S. data. Our results are consistent with Miller's (1977) hypothesis that when opinions about a stock differ, the stock's price will reflect the optimistic traders' view indicating overpricing, and the return of the stock will be abnormally low.