Departures from Rationality in Finance
Saturday, Jan. 6, 2018 8:00 AM - 10:00 AM
Subjective Cash Flows and Discount Rates
AbstractWhat drives stock prices? Using survey forecasts for dividend growth and returns for the S&P 500 index, we find that changes in subjective dividend growth expectations are the main driver of movements in the price-dividend ratio. Subjective dividend growth expectations vary substantially over time and match future dividend growth remarkably well, while subjective return expectations are relatively flat and weakly negatively correlated with future returns. One-year subjective dividend growth expectations explain a large amount of the movements in the price-dividend ratio, accounting for 36% of the total variation. Using longer horizon subjective expectations, we estimate that subjective dividend growth expectations account for at least 73% of the variation in the price-dividend ratio, while subjective return expectations account for at most 27%. These findings highlight the importance of time-varying dividend growth expectations in determining aggregate stock prices.
The Ostrich in Us: Selective Attention to Financial Accounts, Income, Spending, and Liquidity
AbstractA number of theoretical research papers in micro- as well as macroeconomics model and analyze attention but direct empirical evidence remains scarce. This paper investigates the determinants of attention to financial accounts using panel data from a financial management software provider containing daily logins, discretionary spending, income, balances, and credit limits. We argue that our findings cannot be explained by rational theories of inattention, i.e., mechanical information costs and benefits. Instead our findings appear to be more consistent with information- or belief-dependent utility models generating Ostrich effects and anticipatory utility. We find that individuals are considerably more likely to log in because they get paid. Beyond looking at the causal effect of income on attention, we examine how attention depends on individual spending, balances, and credit limits within individuals' own histories. We document that attention is decreasing in spending and overdrafts and increasing in cash holdings, savings, and liquidity. Moreover, attention jumps discretely when balances change from negative to positive. Finally, we show that some of our findings can be explained in a recent influential model of belief-dependent utility developed by Koszegi and Rabin (2009).
Low Interest Rates and Risk Taking: Evidence From Individual Investment Decisions
AbstractWe study the impact of low interest rates on risk taking. We demonstrate that individuals "reach for yield," that is, have a greater appetite for risk taking when interest rates are low. Using randomized investment experiments holding fixed risk premia and risks, we show that low interest rates lead to significantly higher allocations to risky assets, among MTurk subjects and HBS MBAs. This effect also displays non-linearity, and becomes increasingly pronounced as interest rates decrease below historical norms. The behavior is not easily explained by conventional portfolio choice theory or by institutional frictions. We then propose and provide evidence for mechanisms related to investor psychology, including reference dependence and salience. We also present results using historical data on household investment decisions.
- A1 - General Economics