Beliefs and Portfolios: Causal Evidence

67 Pages Posted: 8 Feb 2022 Last revised: 27 Mar 2025

See all articles by Johannes Beutel

Johannes Beutel

Deutsche Bundesbank

Michael Weber

University of Chicago - Finance; National Bureau of Economic Research (NBER)

Date Written: March 05, 2025

Abstract

We causally test alternative theories of expectation formation. Using a randomized information experiment we show overreaction is a key feature of individuals' return expectations, and individuals' response to the price-earnings ratio is opposite to the academic consensus. Our evidence is inconsistent with standard models of expectation formation but subjective mental models that deviate from objective benchmarks can jointly explain the updating behavior in the experiment, the link between individuals' prior perceptions and expectations, and the heterogeneity of their updating behavior. Conditional on their beliefs, individuals' sensitivity of risky portfolio shares is consistent with the standard Merton model of portfolio choice.

Keywords: Expectation formation, asset pricing, household finance

JEL Classification: G11, G12, G41, G51, G53, D84, E44

Suggested Citation

Beutel, Johannes and Weber, Michael, Beliefs and Portfolios: Causal Evidence (March 05, 2025). Chicago Booth Research Paper No. 22-08, Available at SSRN: https://ssrn.com/abstract=4029090 or http://dx.doi.org/10.2139/ssrn.4029090

Johannes Beutel

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

Michael Weber (Contact Author)

University of Chicago - Finance ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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