Electronic copy available at: http://ssrn.com/abstract=1976229 Electronic copy available at: http://ssrn.com/abstract=1976229 Volatility, Investor Uncertainty, and Dispersion Ronald Huisman * Nico L. van der Sar † Remco C.J. Zwinkels ‡ December 23, 2011 Abstract This paper studies the aggregation of investor expectations of stock market return variation and its implications. We motivate theoreti- cally that the market’s expected return variance can be decomposed into the average of individuals’ expected variance plus the dispersion in individuals’ expected mean returns. The former can be seen as risk, while the latter is a measure of uncertainty. We illustrate this result empirically by setting up a unique survey measuring investors’ expected returns and volatilities. Our finding is important to the issue of aggregating heterogeneous beliefs at the micro level in relation to pricing in financial markets. For instance, as a result it is almost per definition that individual investors are overconfident in the sense of overly narrow forecast bounds, due to neglecting individual differences of opinion about mean returns. We furthermore show that investors display a risk-return trade-off, whereas the market seems to price un- certainty. Keywords : volatility, uncertainty, dispersion, survey data JEL - codes: G11, D03 * Erasmus School of Economics, Erasmus University Rotterdam, P.O. Box 1738, 3000 DR, Rotterdam. T: +31 10 408 8925. F: +31 10 408 9165 E: rhuisman@ese.eur.nl † Erasmus School of Economics, Email: vandersar@ese.eur.nl ‡ Erasmus School of Economics, Email: zwinkels@ese.eur.nl We thank Bart Frijns, Andrey Ukhov, Glenn Boyle, Albert Menkveld, Gregory Duffee, Stephan Siegel, Wayne Ferson, William Goetzmann, Werner DeBondt, participants of the 2011 AFBC, the 2011 AFM, as well as participants of seminars at Erasmus University. 1