Robustness and Dynamic Sentiment

52 Pages Posted: 9 Mar 2021 Last revised: 2 Jun 2021

See all articles by Pascal J. Maenhout

Pascal J. Maenhout

INSEAD - Finance

Andrea Vedolin

Boston University - Department of Finance & Economics

Hao Xing

Boston University - Questrom School of Business

Date Written: March 5, 2021

Abstract

Errors in survey expectations display waves of pessimism and optimism and significant sluggishness. This paper develops a novel theoretical framework of time-varying beliefs capturing these empirical facts. In our model, the dynamic beliefs arise endogenously due to agents’ attitude toward alternative models. Decision-maker’s distorted beliefs generate countercyclical risk aversion, procyclical portfolio weights, countercyclical equilibrium asset returns, and excess volatility. A calibrated version of our model is shown to match salient features in equity markets.

Keywords: robust control, subjective beliefs, pessimism, optimism, Cressie-Read

JEL Classification: G11, G12

Suggested Citation

Maenhout, Pascal J. and Vedolin, Andrea and Xing, Hao, Robustness and Dynamic Sentiment (March 5, 2021). Available at SSRN: https://ssrn.com/abstract=3798445 or http://dx.doi.org/10.2139/ssrn.3798445

Pascal J. Maenhout

INSEAD - Finance ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
France

Andrea Vedolin (Contact Author)

Boston University - Department of Finance & Economics ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

Hao Xing

Boston University - Questrom School of Business ( email )

595 Commonwealth Avenue
Boston, MA MA 02215
United States

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