The Cross-section of Subjective Expectations : Understanding Prices and Anomalies

Using survey forecasts, we find that subjective expectations of earnings growth and price growth account for over 90% of cross-sectional variation in stock price-earnings ratios. This is largely due to expected earnings growth, which is more volatile and more correlated with P/E ratios than expected price growth. Due to forecasters consistently overestimating the earnings growth of high P/E firms, errors in expected earnings growth account for 36-43% of all cross-sectional variation in P/E ratios. In contrast to previous findings for the aggregate market, in the cross-section forecasters correctly expect lower price growth for high P/E stocks but understate the magnitude of the relationship. Using 22 anomaly characteristics, we decompose realized price growth on anomaly portfolios and find that expected price growth plays only a minor role. Instead, realized price growth for anomaly portfolios is largely explained by errors in expected earnings growth