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Retail investor beliefs

Survey evidence suggests that retail investors adjust positions rather sluggishly to changing beliefs and the beliefs themselves contradict classic rationality. Sluggishness arises from two features. First, the sensitivity of portfolio choices to beliefs is small. Second, the timing of trades does not depend much on belief changes. Contradictions to classic rationality arise because different investors cling stubbornly to different beliefs with little convergence. Also, retail investors associate higher returns with higher economic growth expectations and lower returns with fears of large drawdowns (contradicting the notion of tail risk premia). Overall this suggests that retail investors feel better informed than the market, with no need for updating their beliefs quickly and thoroughly. Opportunities for professional macro trading may arise through front running retail flows and applying more consistent rationality.

The below post is based on:
Giglio, Stefano, Matteo Maggiori, Johannes Stroebel, Stephen Utkus (2019), “Five facts about beliefs and portfolios”, CESifo Working Paper No. 7666.

The post ties in with the SRSV summary on information efficiency.

The survey

“We provide new evidence on the link between beliefs…and real actions taken by survey respondents. To do this, we administer a newly-designed online expectations survey to a large panel of individual retail investors with substantial wealth invested in financial markets…The survey was administered to a random sample of U.S.-based clients of Vanguard, one of the world’s largest asset management firms… with about USD5.1 trillion in assets under management…80% of the investors we contact have retail trading accounts at Vanguard, while the remaining 20% have employer-sponsored retirement accounts.”

“The survey has been conducted every two months since February 2017. In this paper, we study the first ten survey waves, which generated more than 20,000 total responses.”

Beliefs affect investment, but less than expected by theory

“There is a statistically [significant] relationship between beliefs and portfolio composition.”

“[However,] the sensitivity of portfolios to beliefs is small on average… the average sensitivity of an investor’s equity share to that investor’s perceived risk and expected return of the stock market is substantially lower than predicted by benchmark frictionless macro-finance models. Controlling for various measures of risk perception, a 1%- point increase in expected returns over the next year is associated with a 0.7%-points higher equity share.”

“This sensitivity is higher in tax-advantaged accounts, and is increasing in wealth, investor trading frequency, investor attention, and investor confidence.”

“This relatively small response of equity shares to beliefs about stock returns is qualitatively and quantitatively consistent with evidence documented across a number of other studies.”

Beliefs shape direction, but not timing of trading

“We find that trading occurs infrequently, and that the timing of trades does not depend meaningfully on beliefs… Predicting whether trading occurs over relatively short horizons is difficult, since it can often be caused by factors other than beliefs about risk and returns, such as liquidity needs induced by life events. Our findings are consistent with models of infrequent trading”

“Belief changes have minimal explanatory power for predicting when trading occurs (the extensive margin), but help explain both the direction and magnitude of trading conditional on a trade occurring…Conditional on trading, belief changes affect both the direction and the magnitude of trades.

Beliefs do not converge

“Disagreement about the long run evolution of market prices is an important characteristic of investors’ beliefs…Beliefs are mostly characterized by large and persistent individual heterogeneity.”

“Individual beliefs are mostly characterized by heterogeneous and persistent individual fixed effects. Some individuals are optimistic and some are pessimistic, and their beliefs are persistent and far apart. While there is some co-movement in beliefs across individuals over time, the time variation in average beliefs only accounts for about 1% of the total variation in beliefs in the panel. Instead, between 50% and 60% of all belief variation in our panel is due to individual fixed effects.”

Return expectations depend on economic growth

“Investors who expect higher cash flow growth also expect higher returns and lower long-term price-dividend ratios. “

“We make the imperfect but useful abstraction to consider the economy’s GDP to be the ‘dividend’ paid to the holders of the stock market, so that we can proxy for beliefs about dividend or cash-flow growth using beliefs about GDP growth.”

“Investors disagree about both expected returns and expected cash flow growth, and that their beliefs are positively correlated across these objects: at each point in time, individuals who expect higher cash flow growth also tend to expect higher returns in both the short run and the long run.”

“Even though investors who expect higher cash flows going forward also disproportionately believe that prices will increase in the future (leading them to expect higher returns), the expected increase in prices is not large enough to ensure that investors who disagree about cash flow growth end up agreeing on long-run prices. Indeed, investors who expect higher cash flow growth (and who therefore think assets are currently undervalued) continue to expect prices to be relatively low ten years in the future.”

Disaster fear reduces return expectations

Expected returns and the subjective probability of rare disasters are negatively related, both within and across investors.”

“When individuals expect large stock market declines to occur with higher probability, they also expect stock market returns to be lower. This relationship holds both across individuals and within individuals over time…In standard rational expectations equilibrium models with rare disasters, expected returns and the probability of disaster are positively related. The intuition is that a higher probability of disasters induces individuals to demand higher compensation for holding stocks, and thereby increases equilibrium expected returns. The relationship in the data appears with the opposite sign.”


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