Insensitive Investors

Constantin Charles, Cary D. Frydman and Mete Kilic

No 10067, CESifo Working Paper Series from CESifo

Abstract: We show theoretically that the weak transmission of beliefs to actions induces a strong bias in basic asset pricing tests. In particular, expected returns can appear to decline in risk when investors weakly transmit their payoff expectations into willingness to pay. We experimentally test this prediction and find that subjects exhibit an extremely weak transmission of beliefs to actions, which generates a negative risk-return relation. We argue that the weak transmission is due to cognitive noise and demonstrate that cognitive noise causally affects the risk-return relation. Our results highlight the importance of incorporating weak transmission into belief-based asset pricing models.

Keywords: investor behavior; cognitive noise; portfolio choice (search for similar items in EconPapers)
Date: 2022
New Economics Papers: this item is included in nep-exp, nep-fmk, nep-neu and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_10067

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