Why so Negative? Belief Formation and Risk Taking in Boom and Bust Markets

52 Pages Posted: 19 Jul 2019 Last revised: 24 Jul 2020

See all articles by Pascal Kieren

Pascal Kieren

University of Mannheim

Jan Müller-Dethard

University of Mannheim

Martin Weber

University of Mannheim - Department of Banking and Finance

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Date Written: July 23, 2020

Abstract

What determines investors’ risk-taking across macroeconomic cycles? Researchers have proposed rational expectations models that introduce countercyclical risk aversion to generate the empirically observed time variation in risk-taking. We test whether systematic deviations from rational expectations can cause similar investment patterns without assuming unstable preferences. We let subjects form beliefs in learning environments which resemble characteristics of boom and bust markets, followed by an independent investment task. Subjects, who learned in bust market environments, form overly pessimistic beliefs and invest significantly less in an ambiguous investment option. However, we find no differences in a risky investment option, where expectations are fixed.

Keywords: risk-taking, belief formation, market cycles, return expectations

JEL Classification: D83, D84, E32, E44, G01, G11, G41

Suggested Citation

Kieren, Pascal and Müller-Dethard, Jan and Weber, Martin, Why so Negative? Belief Formation and Risk Taking in Boom and Bust Markets (July 23, 2020). Available at SSRN: https://ssrn.com/abstract=3422681 or http://dx.doi.org/10.2139/ssrn.3422681

Pascal Kieren

University of Mannheim ( email )

Deparment of Finance, L9, 1-2
Mannheim, 68131
Germany

Jan Müller-Dethard (Contact Author)

University of Mannheim ( email )

Department of Finance, L9, 1-2
Mannheim, 68131
Germany

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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