Extrapolation Bias and the Predictability of Stock Returns by Price-Scaled Variables

Psychology-Based Models of Asset Prices and Trading Volume

“…Cassella and Gulen (2018) draw a new prediction out of the extrapolation framework, namely that a high P/D ratio in the stock market will be followed by an especially low average return over the next year if, at the time of the high P/D ratio, the typical investor's θ is low: when θ is low, investors more quickly "forget" the positive price changes that caused them to become excited in the first place, and the overvaluation therefore corrects faster. Cassella and Gulen (2018) confirm this prediction in the data: years of high P/D ratios and low θ are followed by lower returns on average than are years of high P/D ratios and high θ.…”

“…The first wave of formal research on the topic appeared in the 1990s and includes papers such as Cutler et al (1990), De Long et al (1990b, Frankel and Froot (1990), Hong and Stein (1999), and Barberis and Shleifer (2003). Recently, there has been a second wave of research on the topic, including papers such as Barberis et al (2015Barberis et al ( , 2018, Adam et al 2017, Glaeser and Nathanson (2017), Cassella and Gulen (2018), DeFusco et al 2018, Jin and Sui (2018), and Liao and Peng (2018). This second wave has been spurred in part by renewed attention to a neglected but potentially very useful type of data, namely survey data on the beliefs of real-world investors about future asset returns (Bacchetta et al, 2009;Amromin and Sharpe, 2014;Greenwood and Shleifer, 2014).…”

Investor Experiences and Financial Market Dynamics

“…For example, when the market participation of the young relative to the old in the market increases, the relative reliance of prices on more recent dividends increases. This is in line with evidence in Cassella and Gulen (2015) who find that the level of extrapolation in markets is positively related to the fraction of young traders in that market.…”

Investor Irrational Selection Bias in Stock Market Based on Cognitive Psychology: Evidence From Herding Behaviour

“…The extrapolative belief is mainly reflected in the fact that investors extrapolate the future yield or fundamental information of the asset to an increasing function of the most recent return or fundamental information of the asset. To prove the extrapolative effect of investors, some literature has sought evidence from actual transaction data, such as Cassella & Gulen (2018). In addition, some other scholars have sought evidence based on survey data on investor beliefs in the real world, such as Bacchetta et al (2009) and Greenwood & Shleifer (2014).…”