Behavioral Finance: Risk, Beliefs, and Factor Models
Paper Session
Friday, Jan. 7, 2022 12:15 PM - 2:15 PM (EST)
- Chair: Stephan Siegel, University of Washington
Psychological Distance and Deviations from Rational Expectations
Abstract
Empirical evidence shows that households' beliefs deviate from rational expectations. Combining concepts from psychology and robust control, we develop a model where the deviations of beliefs about stock returns from rational expectations are an endogenous outcome of household-firm psychological distance, which encompasses temporal, spatial, and social distance. To make the model testable, we establish the relation between unobservable beliefs and observable portfolio choices. We use portfolio holdings for 405,628 Finnish households and 125 firms to show household-firm spatial distance has a significant distortionary effect on beliefs and welfare, which leads to substantial inequality across households.Risk, Return, and Sentiment in a Virtual Asset Market
Abstract
The joint-hypothesis problem casts doubt on the results of market efficiency research. Specically, it is hard to assess to what extent financial markets reflect economic fundamentals or mispricing. To address this issue, we study price formation in a large virtual asset market where fundamentals are predetermined and publicly known. We find that a number of well-established determinants of returns from the real world also affect asset prices in this market, despite the absence of systematic risk. The results suggest that prices in real financial markets include a substantial behavioral component, which is likely underestimated in canonical asset pricing tests.Investor Sentiment and the Pricing of Characteristics-Based Factors
Abstract
Using portfolios that are formed by directly sorting stocks based on their exposure to characteristics-based factors, earlier studies find that these beta-sorted portfolios have very large ex post factor beta spreads. However, the return spreads between high- and low-beta firms are typically tiny and insignificant. This study examines the time variation in the pricing of a large set of characteristics-based factors. Our evidence shows a striking two-regime pattern for most of the factor-beta-sorted portfolios: high-beta portfolios earn significantly higher returns than low-beta portfolios following high-sentiment periods, whereas the exact opposite occurs following low-sentiment periods. Remarkably, this two-regime pattern is completely reversed when macro-related factors, such as consumption growth and TFP growth, are used. The evidence based on mutual fund and hedge fund returns also confirms this two-regime pattern. Our findings suggest that the exposure to most of these characteristics-based factors is likely to be a proxy for the level of mispricing, rather than risk, especially during high-sentiment periods.Discussant(s)
Ralph S.J. Koijen
,
University of Chicago
Zwetelina Iliewa
,
University of Bonn
Zhi Da
,
University of Notre Dame
Andrew Detzel
,
University of Denver
JEL Classifications
- G2 - Financial Institutions and Services