Keywords: Equity premium, expected returns, behavioral finance
Abstract: We use data obtained from a series of Michigan Surveys of Consumer Attitudes to study
stock market beliefs and portfolio choices of individual investors. We find that expected returns
over the medium- and long-term horizon appear to be extrapolated from past realized returns.
The findings also indicate that a more optimistic assessment of macroeconomic conditions
coincides with higher expected returns and lower expected volatility, implying strongly
procyclical Sharpe ratios. These results are given added credence by the empirical finding that
reported portfolio concentrations in equities tend to be higher for respondents who anticipate
higher returns and lower uncertainty. Overall, our empirical results lend support to the
hypothesis that equity valuations are lower during recessions--and--subsequent returns are
higher--because of undue pessimism about future returns, rather than high risk aversion.
Full paper (1031 KB PDF)
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Last update: May 18, 2005