Recovering Heterogeneous Beliefs and Preferences from Asset Prices
47 Pages Posted: 20 Jul 2020 Last revised: 14 Dec 2022
Date Written: December 13, 2022
We propose a novel information-theoretic approach to identify the risk preferences and beliefs of different investor types. Investors who optimally allocate most of their wealth to large market capitalization stocks are risk averse and believe that the stock market return, and its Sharpe ratio, are countercyclical. Investors in value stocks have similar risk preferences and beliefs. In contrast, investors in momentum and small-growth stocks have procyclical beliefs. Momentum (small-growth) investors are more (less) risk-averse than the large-cap investor. Our findings can reconcile the procyclical expected market returns in survey data with the countercyclical expected returns implied by rational expectations models.
Keywords: asset pricing, beliefs, preferences, heterogeneity, business cycle, rational expectations, behavioral finance, smoothed empirical likelihood
JEL Classification: C51, E3, E70, G12, G14, G40
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