Working Paper: NBER ID: w19189
Authors: Nicholas Barberis; Robin Greenwood; Lawrence Jin; Andrei Shleifer
Abstract: Survey evidence suggests that many investors form beliefs about future stock market returns by extrapolating past returns: they expect the stock market to perform well (poorly) in the near future if it performed well (poorly) in the recent past. Such beliefs are hard to reconcile with existing models of the aggregate stock market. We study a consumption-based asset pricing model in which some investors form beliefs about future price changes in the stock market by extrapolating past price changes, while other investors hold fully rational beliefs. We find that the model captures many features of actual prices and returns, but is also consistent with the survey evidence on investor expectations. This suggests that the survey evidence does not need to be seen as an inconvenient obstacle to understanding the stock market; on the contrary, it is consistent with the facts about prices and returns, and may be the key to understanding them.
Keywords: extrapolative expectations; capital asset pricing model; stock market behavior
JEL Codes: G02; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Past price changes (E30) | Extrapolators' expectations (C51) |
| Extrapolators' expectations (C51) | Stock prices (G19) |
| Cash flow news (G19) | Stock prices (G19) |
| Extrapolators' expectations (C51) | Overvaluation of stock market (G17) |
| Rational traders' expectations (D84) | Demand (R22) |
| Extrapolators (C51) | Excess volatility in stock prices (G17) |
| Consumption changes (E21) | Price changes (P22) |