Machine Forecast Disagreement / Turan G. Bali, Bryan T. Kelly, Mathis Mörke, Jamil Rahman.

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Bali, Turan G

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w31583.Publication details: Cambridge, Mass. National Bureau of Economic Research 2023.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: We propose a statistical model of differences in beliefs in which heterogeneous investors are represented as different machine learning model specifications. Each investor forms return forecasts from their own specific model using data inputs that are available to all investors. We measure disagreement as dispersion in forecasts across investor-models. Our measure aligns with extant measures of disagreement (e.g., analyst forecast dispersion), but is a significantly stronger predictor of future returns. We document a large, significant, and highly robust negative cross-sectional relation between belief disagreement and future returns. A decile spread portfolio that is short stocks with high forecast disagreement and long stocks with low disagreement earns a value-weighted average return of 14% per year. A range of analyses suggest the alpha is mispricing induced by short-sale costs and limits-to-arbitrage.

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August 2023.

We propose a statistical model of differences in beliefs in which heterogeneous investors are represented as different machine learning model specifications. Each investor forms return forecasts from their own specific model using data inputs that are available to all investors. We measure disagreement as dispersion in forecasts across investor-models. Our measure aligns with extant measures of disagreement (e.g., analyst forecast dispersion), but is a significantly stronger predictor of future returns. We document a large, significant, and highly robust negative cross-sectional relation between belief disagreement and future returns. A decile spread portfolio that is short stocks with high forecast disagreement and long stocks with low disagreement earns a value-weighted average return of 14% per year. A range of analyses suggest the alpha is mispricing induced by short-sale costs and limits-to-arbitrage.