Offsetting disagreement and security prices

Byoung-Hyoung Hwang, Dong Lou and Chengxi Yin

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Portfolios often trade at substantial discounts relative to the sum of their components (e.g., closed-end funds, conglomerates). We propose a simple explanation for this phenomenon, drawing from prior research that investor disagreement coupled with short-sale constraints can lead to overvaluation. Specifically, we argue that while investors may strongly disagree at the component level, as long as their relative views are not perfectly positively correlated across components, disagreement will partially offset at the portfolio level. In other words, investors generally disagree less at the portfolio level than at the individual component level, which, coupled with short-sale constraints, provides an explanation for why portfolios trade below the sum of its parts. Utilizing closed-end funds, exchange-traded funds, conglomerates, and mergers and acquisitions as settings where prices of the underlying components and prices of the aggregate portfolio can be separately evaluated, we present evidence supportive of our argument.

Keywords: disagreement; short-sale constraints; belief crossing (search for similar items in EconPapers)
JEL-codes: G11 G12 G14 G20 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2014-11-01
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