Working Paper: NBER ID: w25777
Authors: Aydoan Alti; Sheridan Titman
Abstract: We present a dynamic model that links characteristic-based return predictability to systematic factors that determine the evolution of firm fundamentals. In the model, an economy-wide disruption process reallocates profits from existing businesses to new projects and thus generates a source of systematic risk for portfolios of firms sorted on value, profitability, and asset growth. If investors are overconfident about their ability to evaluate the disruption climate, these characteristic-sorted portfolios exhibit persistent mispricing. The model generates predictions about the conditional predictability of characteristic-sorted portfolio returns and illustrates how return persistence increases the likelihood of observing characteristic-based anomalies.
Keywords: characteristic-based return predictability; investor beliefs; disruption climate; behavioral finance
JEL Codes: G02; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Investor Overconfidence (G41) | Mispricing (G19) |
| Disruption Climate (Q54) | Firm Characteristics (L25) |
| Mispricing (G19) | Predictable Return Differences (G11) |
| Investor Beliefs (G40) | Return Predictability (G17) |
| Disruption Climate (Q54) | Firm Profitability (L21) |
| Disruption Climate (Q54) | Firm Growth Rates (L25) |
| Investor Overconfidence (G41) | Characteristic-Sorted Portfolios Mispricing (G11) |
| Characteristic-Sorted Returns (C69) | Value Premium (D46) |