Abstract
Within a standard risk-based asset pricing framework with rational expectations, realized returns have two components: Predictable risk premiums and unpredictable shocks. In bad times, the price of risk increases. Hence, the predictable fraction of returns – and predictability – increases. “Disagreement” (dispersion in analyst forecasts) also intensifies in bad times if (i) analysts report (close to) risk-neutral expectations weighted by state prices, which become more volatile, or (ii) dividend volatility changes with the price of risk – for example, because consumption volatility changes. In both cases, individual analysts produce unbiased forecasts based on partial information.
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