Working Paper: NBER ID: w29977
Authors: Klaus Adam; Stefan Nagel
Abstract: Asset prices reflect investors' subjective beliefs about future cash flows and prices. In this chapter, we review recent research on the formation of these beliefs and their role in asset pricing. Return expectations of individual and professional investors in surveys differ markedly from those implied by rational expectations models. Variation in subjective expectations of future cash flows and price levels appear to account for much of aggregate stock market volatility. Mapping the survey evidence into agent expectations in asset pricing models is complicated by measurement errors and belief heterogeneity. Recent efforts to build asset pricing models that match the survey evidence on subjective belief dynamics include various forms of learning about payout or price dynamics, extrapolative expectations, and diagnostic expectations. Challenges for future research include the exploration of subjective risk perceptions, aggregation of measured beliefs, and links between asset market expectations and the macroeconomy.
Keywords: Asset Pricing; Expectations; Investor Behavior; Market Volatility
JEL Codes: E71; G12; G41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| subjective beliefs (D80) | asset prices (G19) |
| subjective beliefs (D80) | variations in asset prices (G19) |
| subjective beliefs (D80) | fluctuations in market prices (E32) |
| subjective beliefs (D80) | risk premia (G22) |
| subjective beliefs (D80) | variations in risk premia (G19) |
| traditional RE models (C59) | misrepresentation of risk premia (G41) |