Framing Effects in Stock Market Forecasts: The Difference between Asking for Prices and Asking for Returns
40 Pages Posted: 10 Nov 2005
Date Written: February 5, 2007
Studies analyzing return expectations of financial market participants like fund managers, CFOs or individual investors are highly influential in academia and practice. Examples of such surveys in the U.S. are the Livingston Survey of the Federal Reserve Bank of Philadelphia, the Surveys of Consumers of the University of Michigan, the UBS/Gallup survey, and the Duke/CFO Business Outlook survey. An example from Germany is the ZEW Bankprognosen survey. We argue and show that the results in the surveys above are easily influenced by the elicitation mode of return expectations. Surveys that ask for future stock price levels (like the Livingston Survey) are more likely to produce mean reverting expectations than surveys that directly ask for future returns (like the Michigan Surveys of Consumers or the Duke/CFO Business Outlook survey). Furthermore, we conduct a questionnaire study that explicitly analyzes whether the specific elicitation mode affects return expectations in the above direction. In our study, subjects (students in business administration at two large German universities) were asked to state mean forecasts for seven time series. Using a between subject design, one half of the subjects was asked to state future price levels, the other group was directly asked for returns. We observe a highly significant framing effect. For upward sloping time series, the return forecasts stated by investors in the return forecast mode are significantly higher than those derived for investors in the price forecast mode. For downward sloping time series, the return forecasts given by investors in the return forecast mode are significantly lower than those derived for investors in the price forecast mode. We argue that this finding is consistent with behavioral theories of investor expectation formation that are based on the representativeness heuristic.
Keywords: Return forecast, volatility forecast, confidence interval, individual investor, overconfidence, expertise, financial education, financial literacy, framing effect, investor surveys
JEL Classification: C9, G1
Suggested Citation: Suggested Citation