Recovering Investor Expectations from Demand for Index Funds
76 Pages Posted: 11 Jan 2020 Last revised: 31 Aug 2020
Date Written: August 27, 2020
Abstract We use a revealed-preference approach to estimate investor expectations of stock market returns. Using data on demand for index funds that follow the S&P 500, we develop and estimate a model of investor choice to flexibly recover the time-varying distribution of expected returns. Our analysis is facilitated by the prevalence of “leveraged” funds that track the same underlying asset: by choosing between higher and lower leverage, investors trade off higher return against less risk. Although generated from a different method (realized choices) and a different population, our quarterly estimates of investor expectations are positively and significantly correlated with the leading surveys used to measure stock market expectations. Our estimates suggest that investor expectations are heterogeneous, extrapolative, and persistent. Following a downturn, investors become more pessimistic on average, but there is also an increase in disagreement among participating investors due to the presence of a large fraction of contrarian investors.
Keywords: Stock Market Expectations, Demand Estimation, Exchange-Traded Funds (ETFs)
JEL Classification: D12, D81, D84, G11, G50, L0
Suggested Citation: Suggested Citation