Do Divergent Opinions Explain the Value Premium?

Abstract

The risk explanation for value stocks’ long-run outperformance (i.e., the value premium) is theoretically compelling, but what these risks are remains controversial. Doukas et al. [2004] suggest that the risk may be divergent opinions. Specifically, using analysts’ forecast dispersion as a proxy for divergent opinions, they find that value stocks have significantly higher divergent opinions. This article further explores the divergent opinions explanation of the value premium by directly examining how divergent opinions affect stock returns. Contrary to the prediction of the divergent opinions explanation, we find that firms with greater exposure to divergent opinions do not earn higher excess returns, and the results hold for both value and growth stocks. In fact, firms with higher divergent opinions seem to earn slightly lower (though insignificant) returns than those with lower exposure to divergent opinions. Our results therefore cast doubt on the divergent opinions explanation of the value premium.