Working Paper: NBER ID: w26608
Authors: Mark L. Egan; Alexander Mackay; Hanbin Yang
Abstract: We use a revealed-preference approach to estimate investor expectations of stock market returns. Using data on demand for index funds that follow the S&P 500, we develop and estimate a model of investor choice to flexibly recover the time-varying distribution of expected future returns across investors. Our analysis is facilitated by the prevalence of leveraged funds that track the same underlying asset: by choosing between higher and lower leverage, investors trade off higher return against less risk. Our estimates indicate that investor expectations are heterogeneous, extrapolative, and persistent. Following a downturn, investors become more pessimistic on average, but there is also an increase in disagreement among participating investors due to the presence of contrarian investors.
Keywords: Investor Expectations; Index Funds; S&P 500; Leveraged ETFs; Behavioral Economics
JEL Codes: D12; D81; D84; G11; G50
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| investor expectations are heterogeneous (D84) | investor purchasing behavior (G11) |
| investor expectations are extrapolative (D84) | investor purchasing behavior (G11) |
| investor expectations are persistent (D84) | investor purchasing behavior (G11) |
| downturn (E32) | investor pessimism (G41) |
| downturn (E32) | disagreement among investors (G40) |
| choice of leveraged ETF (G11) | expectations about future stock market performance (G17) |
| choice of leveraged ETF (G11) | risk preferences (D81) |
| mean expectation of returns is negatively correlated with dispersion of beliefs (D80) | lower future returns (G12) |
| average forecast errors are predictable (C53) | violation of full-information rational expectations (D84) |
| past returns and dispersion of beliefs (D80) | forecast errors (C53) |