Which Subjective Expectations Explain Asset Prices?

63 Pages Posted: 22 Jun 2021 Last revised: 22 Nov 2022

See all articles by Ricardo De la O

Ricardo De la O

University of Southern California - Marshall School of Business

Sean Myers

The Wharton School, University of Pennsylvania

Date Written: November 1, 2022

Abstract

We present a method for determining whether errors in expectations explain asset pricing puzzles without imposing assumptions about the mechanism of the error. Using accounting identities and survey forecasts, we find that errors in expected long-term inflation and short-term nominal earnings growth explain price variation, return predictability, and the rejection of the expectations hypothesis for aggregate stock and bond markets. Errors in expected short-term inflation and long-term nominal earnings growth play no role. The relevant errors are consistent with mistakes about both the persistence of forecasted variables and the response to surprises. A fundamental extrapolation model successfully replicates these findings.

Keywords: subjective expectations, inflation expectations, subjective term structure, fundamental extrapolation, expectations hypothesis

JEL Classification: G40, G12, G14, E71

Suggested Citation

De la O, Ricardo and Myers, Sean, Which Subjective Expectations Explain Asset Prices? (November 1, 2022). USC Marshall School of Business Research Paper Sponsored by iORB, No. Forthcoming, Available at SSRN: https://ssrn.com/abstract=3867773 or http://dx.doi.org/10.2139/ssrn.3867773

Ricardo De la O (Contact Author)

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd, HOH 803
Los Angeles, CA California 90089-1424
United States

Sean Myers

The Wharton School, University of Pennsylvania ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

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