Stock Return Expectations

Question 1

Key Considerations when Eliciting Surveys on Stock return Expectations

Answer 1

i) Is the wording understandable to laypeople?
ii) Does the question capture the objective of interest according to theoretical models?
iii) Do we survey a relevant sample of respondents?
iv) Can we link survey data to administrative data on investment decisions?

Question 2

How can we measure Stock market expectations?

Answer 2

1. Point Forecast
2. Subjective probability distribution
   “1.” Less effort for respondents, but captured moment is unclear
   “2.”Capture all moments of the distribution, BUT change peoples beliefs via framing by labeling distribution bins

Question 3

1. Property, Heterogeneity & Implications:

Answer 3

1.) Return Expectations are Heterogeneous
- persistent disagreement
i) Private Info, Public Info, Different level of attention
Disagreement can explain heterogeneity in portfolio shares

Implications:
- Disagreement can explain heterogeneity in portfolio shares
- Standard representative agent models do not include heterogeneity

Question 4

3rd Property, Pro-Cyclicality

Answer 4

Return Expectations are correlated with business cycles.
Reasons:
i) Neglect of Equilibrium Prices
ii) Question Substitution
iii) Mood and Effect
Contrary to literature

Implications:
- Actual objective returns are counter-cyclical to compensate risk bearing during recessions
-> Pro-cyclical returns can lead to investment mistakes and affect equilibrium prices (mispricing)!

Question 5

2nd Property, Extrapolation & implications:

Answer 5

Return expectations vary with recent returns
positive correlation between recent return and expectations
Investors assume positive autocorrelation between returns
Reasons for Extrapolation:
i) Use of Heuristics
ii) Law of Small Numbers
iii) Flash Mental Models
iv) Memory and Experiences
v) Asset Ownership

Implications:
- Autocorrelation of actual returns ic close to zero
(- Heterogenous perceived autocorrelation supports model with heterogenous forecasting)
-> Can lead to investment mistakes!

Question 6

Extensive Margin

Answer 6

Whether I invest in stocks or not

Question 7

Intensive market

Answer 7

If I invest what share of my portfolio do I invest in stocks?

Question 8

Do expectations affect the intensive margin?

Answer 8

Equity share depends on the coefficient of relative risk aversion and the perceived riskiness of a stock

Question 9

What are empirical results on equity share:

Answer 9

Empirically measured beta is substantially below theory predictions. This suggests that portfolios are insensitive to beliefs.
Explanations 1:
- Measurement error
Explanation 2: Frictions
- inattention
- lack of confidence
- portfolio adjustment cost

Behavioral Attenuation from complexity of decisions

Question 10

Why study stock return expectations?

Answer 10

• Standard portfolio choice theory
  -> expected return is key determinant on equity share
• Understanding household finance puzzle
  -> non part. might originate in mis-guided beliefs
• Broad relevance
  -> insights over aggregate outcomes