Expectations and Stock Market Participation: Theory and Evidence

Abstract

Recent evidence suggests that stock market experiences, i.e. realized returns, impact subjective expected returns. I bring a model into the laboratory and find that experience-based subjective expected returns can help explain limited stock market participation. In the experiment, the probability of subjects participating in the stock market is increasing in both their subjective expected returns and past realized returns. I find that learning from generates heterogeneity in subjective expected returns, where subjects who low returns have lower subjective expected returns than subjects who only observe low returns. This experience effect is asymmetric, where subjects who experience high returns have no statistically significant difference in their subjective expected returns than subjects who only observe high returns. Finally, after a series of low returns, a fraction of subjects leave the stock market indefinitely.