In this paper, I examine whether stock return dispersion (RD) provides useful information about future stock returns. RD consistently forecasts a decline in the excess market return at multiple horizons, and compares favorably with alternative predictors used in the literature. The out-of-sample performance of RD tends to beat the alternative predictors, and is economically significant as indicated by the certainty equivalent gain associated with a trading investment strategy. RD has greater forecasting power for big and growth stocks compared to small and value stocks, respectively. I discuss a theoretical mechanism giving rise to the negative correlation between RD and the equity premium.
Maio, P. (2016). Cross-sectional return dispersion and the equity premium. Journal of Financial Markets, 29, 87–109. https://doi.org/10.1016/j.finmar.2015.09.001