Discussion of ‘‘Information Uncertainty
and Expected Returns’’
PAUL SCHULTZ Schultz.email@example.com
260 Mendoza College of Business, University of Notre Dame, Notre Dame, IN, 46556
Abstract. Jiang, Lee, and Zhang (Review of Accounting Studies, 2005, this issue) show that stock returns
are smaller for young ﬁrms, volatile stocks, high volume stocks, and stocks with long equity durations. In
addition to having lower returns, momentum eﬀects are particularly strong in these stocks. The focus of
this discussion is on the informal behavioral model that is used to explain these results and how well the
variables used in the study proxy for information uncertainty, the model’s focus.
Keywords: behavioral ﬁnance, momentum
JEL Classfication: G12, G14
Jiang et al. (2005) (henceforth JLZ) report several interesting empirical results.
Returns are smaller if ﬁrms are: (1) younger, (2) have greater volatility, (3) have
greater turnover, or (4) have a longer equity duration. In addition, the ﬁrms with
lower returns are found to have particularly large momentum eﬀects. Each of these
variables is intended to proxy for information uncertainty, deﬁned as the precision
with which ﬁrm value can be estimated by knowledgeable investors at reasonable
costs. The authors contend that behavioral ﬁnance theory predicts mispricing of
securities when information uncertainty is high. Overconﬁdence refers to the ten-
dency of investors to overestimate the precision of their information signals. JLZ
suggest that overconﬁdence may be especially important when values are ambiguous
and uncertain. In addition, stocks with high levels of information uncertainty may be
more diﬃcult to arbitrage. Together, these two factors suggest that stocks with high
levels of uncertainty may be overpriced and hence produce low returns. JLZ also
propose that the momentum eﬀect will be stronger for high information cost ﬁrms.
The idea is that with more uncertainty, investors will be more reliant on their own
private signals and will ignore past returns in their trading decisions.
1. The Model
The model used in JLZ is an informal one. The ﬁrst critical component of the model
is overconﬁdence, a bias that is well documented in the psychology literature. The
second is limits to arbitrage. This includes short sale costs, noise trader risk, and all
of the frictions that keep rational investors from exploiting mispricing.
JLZ contend that both of these factors are particularly important for stocks with
high information uncertainty. With high information uncertainty it is diﬃcult to
Review of Accounting Studies, 10, 223–226, 2005
Ó 2005 Springer Science+Business Media, Inc., Manufactured in The Netherlands.