The Information Content of Investors' Expectations for Risk and Return

Abstract

This study reveals the information content of individual investors’ risk-adjusted return expectations. Although individual investors overestimate the performance of their stock purchases on average, the cross-sectional variation in their risk-adjusted return expectations is predictive of future risk-adjusted stock performance. Stock purchases that investors expect to outperform the most do outperform the stock purchases that investors expect to outperform the least by an annualized alpha of 16%. The best performing stocks are those that investors with excellent experience expect to outperform the most while the worst performing stocks are those that investors with limited experience expect to outperform the least. The most experienced investors appear to be successfully using information gathered from personal experience with the company's products or services, contact with someone who works for or with the company on a regular basis, and proximity to the company's operations.

Keywords: individual investors, overconfidence, expectations, risk and return

JEL Classification: G11, G14