An investment-based explanation for the dispersion anomaly

We provide an investment-based explanation for the dispersion anomaly. The firms’ optimality condition predicts that expected stock returns equal investment returns (the ratio of expected marginal benefits of investment to marginal costs of investment). We show that the investment model does a good job in explaining the dispersion portfolios. Firms with high forecast dispersion have low expected profitability, which is a key component of expected marginal benefit of investment. Consequently, high forecast dispersion portfolio earns lower expected returns. Our results suggest that the dispersion anomaly could be consistent with the firms’ value maximization.