Beliefs and Portfolios: Causal Evidence
67 Pages Posted: 8 Feb 2022 Last revised: 27 Mar 2025
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: 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
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