Divergence of Opinion and Risk

Abstract

Edward Miller [5], expanding on the work of Williams [8], Smith [6], and Lintner [4], has proposed a direct relationship between a stock's “risk” and its “divergence of opinion.” Under conditions of uncertainty, potential investors in a stock arrive at different assessments of expected return. Thisvariation in expectations is characterized as the stock's divergence of opinion. Miller argues persuasively that at a point in time a stock's price does not reflect the expectations of all potential investors, but rather the expectations of only the most optimistic minority who are trading the issue. As long as this minority can absorb the entire supply of stock, an increase (decrease) in divergence of opinion-leaving the average expectation unchanged-will increase (decrease) the market clearing price.