Past Returns and the Perceived Sharpe Ratio
39 Pages Posted: 1 Dec 2014 Last revised: 5 Feb 2018
Date Written: March 16, 6
We find that human perception contradicts the market efficiency assertions that high return is accompanied by high risk and that past returns do not affect future prices. A survey of investors reveals that the last week realized returns are positively correlated with perceived returns and negatively correlated with perceived risk. Thus, in the human mind there is a free lunch opportunity, where the perceived Sharpe ratio is positively correlated with short-term past returns. As higher perceived Sharpe ratios are also followed by more actual stock buying, our study provides a novel explanation to the observed short-term autocorrelations in stock returns.
Keywords: Expected return; Perceived risk; Perceived Sharpe ratio; stock return autocorrelations
JEL Classification: D81, G02, G10, G14
Suggested Citation: Suggested Citation