The Subjective Risk and Return Expectations of Institutional Investors

Abstract

We use the long-term Capital Market Assumptions of major asset managers and institutional investor consultants from 1987 to 2022 to study their subjective risk and return expectations across 19 asset classes. We find a strong and positive subjective risk-return tradeoff, with the vast majority of the variability in subjective expected returns coming from subjective risk premia (compensation for market beta) rather than subjective alphas. Belief variation and the positive risk-return tradeoff are both stronger across asset classes than across institutions, underscoring the need to study subjective beliefs across multiple asset classes. We also show that subjective expected returns aggregated across institutions predict future realized returns across asset classes and over time, with most of this predictability driven by subjective risk premia, not alphas. Overall, our findings suggest it is important to include a strong risk premia component when modeling the subjective return expectations of institutional investors.

Keywords: Institutional Investors, Subjective Beliefs, Subjective Expected Returns, Subjective Risk, Subjective Risk Premia

JEL Classification: G11, G12, G23