Working Paper: CEPR ID: DP14647
Authors: Martin Weber; Pascal Kieren; Jan Mueller-Dethard
Abstract: An increasing number of studies depart from the rational expectations assumption to reconcile survey expectations with asset prices. While surveys are helpful to establish a link between subjective beliefs and investment decisions, they do not allow inference about how investors depart from rational expectations. In this paper, we provide direct experimental evidence of how systematic distortions in investors’ expectations affect their risk-taking across market cycles. As mechanism, we identify an asymmetry in how individuals update their expectations across boom and bust markets. The documented mechanism is consistent with survey data and provides important implications for recently proposed asset pricing models.
Keywords: risk-taking; belief formation; market cycles; return expectations
JEL Codes: D83; D84; E32; E44; G01; G11; G41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| bust market environments (E32) | lower risk-taking in investment (G11) |
| bust treatment (E65) | more pessimistic beliefs about success probability (D80) |
| pessimistic beliefs (D91) | lower risk-taking in investment (G11) |
| asymmetric updating of beliefs (D83) | more pessimistic beliefs in bust markets (E32) |
| bust learning environments (D29) | pessimistic forecasts for the Dow Jones (G17) |