Asset Pricing: Belief Formation and Market Efficiency
Paper Session
Sunday, Jan. 7, 2024 8:00 AM - 10:00 AM (CST)
- Chair: Lars Lochstoer, University of California-Los Angeles
Extrapolating Long-Term Cash Flow Expectations from Returns
Abstract
This paper documents that equity analysts tend to revise their forecasts about long-term earnings— earnings beyond two years—to rationalize stock price movements, even when the price movements are driven by shocks identified by economists as not cash flow-related. Moreover, these price-driven changes in beliefs tend to revert subsequently. These findings indicate that the observed high correlation between stock returns and changes in subjective valuation implied by analysts’ earnings forecasts reflects, in part, reverse causality from prices to beliefs. We estimate this channel and find that it accounts for approximately one-third of the stock-level correlation and for approximately half of the market-level correlation. Assuming that analyst forecasts are a good proxy of investor beliefs, this channel provides a possible microfoundation for inelastic demand and excess price volatility.The Subjective Risk and Return Expectations of Institutional Investors
Abstract
We use the long-term Capital Market Assumptions of major asset managers and institutional investor consultants from 1987 to 2022 to provide three stylized facts about their subjective risk and return expectations on 19 asset classes. First, there is a strong and positive subjective risk-return tradeoff, with most of the variability in subjective expected returns due to variability in subjective risk premia (compensation for market beta) as opposed to subjective alphas. Second, belief variation and the positive risk-return tradeoff are both stronger across asset classes than across institutions. And third, the subjective expected returns of these institutions predict subsequent realized returns across asset classes and over time. Taken together, our findings imply that models with subjective beliefs should reflect a risk-return tradeoff. Additionally, accounting for this subjective risk-return tradeoff when modeling multiple asset classes is even more important than incorporating average belief distortions or belief heterogeneity in our setting.Conservative Holdings, Aggressive Trades: Ambiguity, Learning, and Equilibrium Flows
Abstract
We study equilibrium asset prices and portfolio flows in a model where agents learn about economic fundamentals and differ in their aversion to parameter uncertainty. Exploiting the connection between confidence intervals from classical statistics and multi-prior sets for ambiguity-sensitive decision makers, we show that, because ambiguity-averse agents hold conservative portfolios, in equilibrium they have more risk-bearing capacity, making them natural buyers of risky assets when volatility rises. The model generates time-varying risk premia that are amplified by bad news and dampened by good news.We provide empirical support for our model predictions using a novel dataset of trading activity on Euro Stoxx 50 futures contracts.
Discussant(s)
Ricardo De la O
,
University of Southern California
Christopher Polk
,
London School of Economics
Markus Ibert
,
Copenhagen Business School and Danish Finance Institute
Hengjie Ai
,
University of Wisconsin-Madison
JEL Classifications
- G1 - General Financial Markets