Why so Negative? Belief Formation and Risk Taking in Boom and Bust Markets

Martin Weber, Pascal Kieren and Jan Mueller-Dethard

No 14647, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: An increasing number of studies depart from the rational expectations assumption to reconcile survey expectations with asset prices. While surveys are helpful to establish a link between subjective beliefs and investment decisions, they do not allow inference about how investors depart from rational expectations. In this paper, we provide direct experimental evidence of how systematic distortions in investors’ expectations affect their risk-taking across market cycles. As mechanism, we identify an asymmetry in how individuals update their expectations across boom and bust markets. The documented mechanism is consistent with survey data and provides important implications for recently proposed asset pricing models.

Keywords: Risk-taking; Belief formation; Market cycles; Return expectations (search for similar items in EconPapers)
JEL-codes: D83 D84 E32 E44 G01 G11 G41 (search for similar items in EconPapers)
Date: 2020-04
New Economics Papers: this item is included in nep-exp, nep-mac and nep-ore
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