Recovering Investor Expectations from Demand for Index Funds
86 Pages Posted: 11 Jan 2020 Last revised: 21 Apr 2021
Date Written: April 20, 2021
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 future returns across investors. 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. Our estimates indicate 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 contrarian investors.
Keywords: Stock Market Expectations, Demand Estimation, Exchange-Traded Funds (ETFs)
JEL Classification: D12, D81, D84, G11, G50, L0
Suggested Citation: Suggested Citation