Speculating on Higher Order Beliefs

62 Pages Posted: 29 Jul 2023 Last revised: 3 Aug 2023

See all articles by Paul Schmidt-Engelbertz

Paul Schmidt-Engelbertz

Yale School of Management

Kaushik Vasudevan

Mitchell E. Daniels, Jr School of Business, Purdue University

Date Written: July 26, 2023

Abstract

Higher order beliefs - beliefs about others' beliefs - may be important for trading behavior and asset prices, but have received little systematic empirical examination due to challenges in measurement. We study more than twenty years of evidence from the Robert Shiller Investor Confidence surveys, which directly elicit details on individual and institutional investors' higher order beliefs about the U.S. stock market. We find that investors' higher order beliefs provide substantial motivations for non-fundamental speculation, e.g., to buy into a stock market perceived to be overvalued. Guided by the evidence, we construct a theoretical model that reveals that higher order beliefs may substantially amplify stock market fluctuations. When investors exhibit the same fundamental belief biases that they attribute to other investors, phenomena such as overreaction, momentum, and reversal can persist in equilibrium even though everybody knows about them.

Suggested Citation

Schmidt-Engelbertz, Paul and Vasudevan, Kaushik, Speculating on Higher Order Beliefs (July 26, 2023). Available at SSRN: https://ssrn.com/abstract=4521891 or http://dx.doi.org/10.2139/ssrn.4521891

Paul Schmidt-Engelbertz

Yale School of Management ( email )

165 Whitney Ave
New Haven, CT 06511

Kaushik Vasudevan (Contact Author)

Mitchell E. Daniels, Jr School of Business, Purdue University ( email )

403 Mitch Daniels Blvd.
West Lafayette, IN 47907
United States

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