The Perception of Dependence, Investment Decisions, and Stock Prices

87 Pages Posted: 29 Feb 2016 Last revised: 24 Mar 2017

Michael Ungeheuer

Aalto University School of Business

Martin Weber

University of Mannheim - Department of Banking and Finance

Multiple version iconThere are 3 versions of this paper

Date Written: March 23, 2017

Abstract

How do investors perceive dependence between stock returns? And how does their perception of dependence affect investments and stock prices? We show experimentally that investors understand differences in dependence, but not in terms of correlation. Subjects rather assess the frequency of comovement by applying a simple counting heuristic. Consequently, they diversify more when the frequency of comovement is lower even if correlation is higher. Building on our experimental findings, we conduct an empirical analysis of 1963-2015 US stock returns revealing a robust return premium for stocks with high frequencies of comovement with the market return.

Keywords: Biased Beliefs, Dependence, Investment Decisions, Correlation Neglect, Diversification, Asset Pricing

JEL Classification: C91, G02, G11, G12

Suggested Citation

Ungeheuer, Michael and Weber, Martin, The Perception of Dependence, Investment Decisions, and Stock Prices (March 23, 2017). Available at SSRN: https://ssrn.com/abstract=2739130 or http://dx.doi.org/10.2139/ssrn.2739130

Michael Ungeheuer (Contact Author)

Aalto University School of Business ( email )

P.O.Box 21220
Helsinki, 00076
Finland

HOME PAGE: http://sites.google.com/site/ungeheuermichael/

Martin Weber

University of Mannheim - Department of Banking and Finance ( email )

D-68131 Mannheim
Germany
+49 621 181 1532 (Phone)
+49 621 181 1534 (Fax)

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