Optimism, Pessimism, Disagreement and Stock Returns

The project aims at understanding the implications of preference interdependence for international stock returns. The empirical approach will be based on Curatola and Dergunov (2017). They build a two-country model where preferences are interdependent because they depend on the popularity of internationally traded goods. More precisely, preferences evolve in favour of goods with the highest demand among international consumers. In equilibrium, a preference shift toward goods produced by a given country generates both a substitution and a wealth effect that have opposite effects on aggregate price-dividend ratios. Therefore, when preferences of international consumers move toward goods produced by a given country, the stock returns of that country may increase or decrease depending on which of the two effects prevails. In addition the model predicts than when stock returns of a given country increase (decrease) in reaction to a positive preference shock the stock return of the other country decreases (increase). In order to provide preliminary evidence in favour of this predictions we i) use the equilibrium equations of Curatola and Dergunov (2017) to back out preference/supply shocks that affect international equity markets and ii) we estimate the beta of international stock returns to preference/supply shocks. Results attached (please see Excel Sheet 2018_SAFE-Project-Application_CuratolaDergunov.xlsx "Tabelle 1" ) suggest that the beta associated to preference shocks is significant. Moreover, consistent with the model predictions, countries react asymmetrically to preference shocks: for instance a positive shock to preferences for German products (compared to UK products) is positvely related to German stock returns and negatively related to returns in UK. Clearly,those are preliminary results and more tests are needed to show that the results are robust. However we believe that these results suggest that the link between preference interdependence and stock returns is worth investigating.