Why so Negative? Belief Formation and Risk Taking in Boom and Bust Markets
50 Pages Posted: 19 Jul 2019 Last revised: 6 Aug 2021
Date Written: August 4, 2021
An increasing number of studies depart from the rational expectations assumption to reconcile survey expectations with asset prices. While surveys are helpful to establish a link between subjective beliefs and investment decisions, they do not allow inference about how investors depart from rational expectations. In this paper, we provide direct experimental evidence of how systematic distortions in investors’ expectations affect their risk-taking across market cycles. As mechanism, we identify an asymmetry in how individuals update their expectations across boom and bust markets. The documented mechanism is consistent with survey data and provides important implications for recently proposed asset pricing models.
Keywords: risk-taking, belief formation, market cycles, return expectations
JEL Classification: D83, D84, E32, E44, G01, G11, G41
Suggested Citation: Suggested Citation