Expectations of Risk and Return Among Household Investors: Are Their Sharpe Ratios Countercyclical?

Abstract:     
Data obtained from special questions on a series of Michigan Surveys of Consumer Attitudes are used to analyze stock market beliefs and portfolio choices of household investors. We find that expected risk and returns are strongly influenced by expected economic conditions. When investors believe macroeconomic conditions are more expansionary, they tend to expect both higher returns and lower volatility. This finding is sharply at odds with the canonical view that stock market returns should compensate investors for exposure to macroeconomic risks. We further find that perceived risk in equity returns (though not the expected returns) is strongly influenced by a number of well-documented behavioral biases. The relevance of investors’ reported expectations is supported by the finding that portfolio equity positions tend to be higher for those respondents that anticipate higher expected returns and lower uncertainty.

Number of Pages in PDF File: 43

Keywords: Equity premium, investor survey, investor expectations, time-varying expected returns

JEL Classification: G28

working papers series