Expectations of Returns and Expected Returns

We analyze time-series of investor expectations of future stock market returns from six data sources between 1963 and 2011. The six measures of expectations are highly positively correlated with each other, as well as with past stock returns and with the level of the stock market. However, investor expectations are strongly negatively correlated with model-based expected returns. We reconcile the evidence by calibrating a simple behavioral model, in which fundamental traders require a premium to accommodate expectations shocks from extrapolative traders, but markets are not efficient.

<p><strong>Background</strong><strong>: </strong>This study seeks to explore the connection between profitability and stock returns, specifically investigating how past stock returns influence profitability and how profitability impacts future stock returns. The research focuses on banking companies listed in the IDX Finance index during the 2020-2023 period.</p><p><strong>Objective</strong><strong>: </strong>This study aims to offer empirical evidence regarding the impact of past stock returns on profitability and the impact of profitability on future stock returns.</p><p><strong>Research Methods</strong><strong>: </strong>This study utilizes a quantitative approach, focusing on a sample of 37 conventional banks that exists on the Indonesia Stock Exchange (IDX) Finance in 2020 – 2023. Data analysis was performed using the PLS-SEM method, with the assistance of SmartPLS 4.0 software.</p><p><strong>Research Results</strong><strong>: </strong>The study findings revealed that past stock returns significantly enhance the net interest margin (NIM), which in turn positively influences the return on assets (ROA). Consequently, ROA plays a vital role in driving future stock returns upward.</p><p><strong>Research Originality/Novelty</strong><strong>:</strong> This research provides fresh perspectives by examining the connection between profitability and stock returns, both historically and prospectively, within the context of Indonesia's banking sector. Additionally, it highlights the factors that impact stock returns and the profitability of banking institutions.</p>

The budgets for research and development (R&D) and marketing should be determined by managers to attain product market advantages. However, in response to investor expectations for short-term stock returns, managers may modify these budgets myopically to avoid unexpected short-term earnings shortfalls, at the cost of long-term profitability. We propose that the past behavior of firm stock returns and volatility may create investor expectations of short-term financial performance, which drives managers to modify either R&D or marketing budgets or both. In the context of high-technology firms, a Bayesian vector autoregression model, supported by content analysis, shows that few firms exhibit high levels of managerial myopia by simultaneously cutting both R&D and marketing budgets; instead, firms display moderate myopic reactions, in the form of unanticipated decreases in R&D budgets but increased budgets for marketing functions. The tendency to manage myopically in response to past stock returns and volatility increases as firm size or industry concentration decrease.This paper was accepted by Pradeep Chintagunta and Preyas Desai, special issue editors.This paper was accepted by Pradeep Chintagunta and Preyas Desai, special issue editors.

We design, field and exploit novel survey data, from a representative sample of the French population in December 2014 and May 2015 to provide insights regarding social interactions and whether they are informative for financial decisions, or they encourage imitation, mindful or mindless. We provide a model where purely informative social interactions influence subjective expectations of future stock market returns and demand for investing in stocks, and find strong support for the presence of informative social interactions. The extent to which the respondent's financial circle is informed about or participates in stockholding appears to influence perceptions of recent stock returns and, only through them, expectations of future returns. Controlling for subjective expectations, stock market participation and the conditional portfolio share are positively influenced by the extent to which the financial circle is informed about or participating in the stock market. Alongside informative social interactions with the respondent's financial circle, we also find some evidence of mindless imitation of stock market participation observed in the outer social circle. These findings suggest that informative social interactions are significant and create a social multiplier for financial education and information, even though the potential for mindless imitation is also present.

This dissertation is composed of three chapters addressing the connections between investor beliefs and asset pricing. Specifically, I focus on one prevailing pattern of investor beliefs in the finance literature, return extrapolation. The idea is that investor expectations about future market returns are a positive function of the recent past returns. In this dissertation, I use this concept to understand a number of facts in the asset pricing literature. Return extrapolation attracts growing attention in the literature, not only because it well explains real-world investors' expectations in the survey, but also because it significantly drives investor demand towards stocks. Therefore, we should anticipate a connection between return extrapolation measurement and the stock market dynamics. However, contrary to the intuition, previous empirical studies fail to document a significant connection. In Chapter 1, Time-varying Impact of Investor Sentiment, I recover this connection. Specifically, I formally define investors who extrapolate past returns as extrapolators and incorporate their wealth level into analysis. My main finding is that return extrapolation interacts strongly with extrapolators' wealth level in predicting future market returns. Therefore, conditional on extrapolators' wealth level, return extrapolation significantly explains stock market returns. The return extrapolation concept also raises challenges to the asset pricing models under the rational expectation frameworks. Specifically, rational expectation theories lead to a positive correlation between expectations and future realized returns, whereas return extrapolation indicates a negative correlation. Given this discrepancy, there is a clear demand for a behavioral asset pricing model that can simultaneously explain survey evidence on investor expectations and the classical asset pricing puzzles. In Chapter 2, Asset Pricing with Return Extrapolation, coauthored with Lawrence Jin, we present a new model of asset prices based on return extrapolation. The model is a Lucas-type general equilibrium framework, in which the agent has Epstein-Zin preferences and extrapolative beliefs. Unlike earlier return extrapolation models, our model allows for a quantitative comparison with the data on asset prices. When the agent's beliefs are calibrated to match survey expectations of investors, the model generates excess volatility and predictability of stock returns, a high equity premium, a low and stable risk-free rate, and a low correlation between stock returns and consumption growth. In Chapter 3, Dark Matter of Finance in the Survey, I investigate another attribute of investor beliefs—tail risk perceptions. Although tail risks play significant roles in explaining asset pricing puzzles, researchers have very limited knowledge about them because tail events are difficult to observe. I use Shiller tail risk survey to empirically investigate tail risk perceptions. In this survey, investors are asked to report their estimated probability for a crash event in the U.S. stock market. However, when using survey data to understand investors’ perception of tail risks, there are two fundamental challenges. First, is tail risks survey reliable? Second, to avoid cherry-picking, is there a unified framework to explain different attributes of investor beliefs? My analysis provides positive answers to both questions. First, I show that Shiller tail risk survey is reliable. More importantly, I show that return extrapolation can serve as a unified belief formation framework to explain not only variations in investor expectations but also in tail risk perceptions.

The Impact of Risk and Return Perceptions on the Portfolio Reallocation Decisions of Mutual Fund Investors

We design, field and exploit novel survey data, from a representative sample of the French population in December 2014 and May 2015 to provide insights regarding social interactions and whether they are informative for financial decisions, or they encourage imitation, mindful or mindless. We provide a model where purely informative social interactions influence subjective expectations of future stock market returns and demand for investing in stocks, and find strong support for the presence of informative social interactions. The extent to which the respondent's financial circle is informed about or participates in stockholding appears to influence perceptions of recent stock returns and, only through them, expectations of future returns. Controlling for subjective expectations, stock market participation and the conditional portfolio share are positively influenced by the extent to which the financial circle is informed about or participating in the stock market. Alongside informative social interactions with the respondent's financial circle, we also find some evidence of mindless imitation of stock market participation observed in the outer social circle. These findings suggest that informative social interactions are significant and create a social multiplier for financial education and information, even though the potential for mindless imitation is also present.

According to the EMH (Efficient Market Hypothesis), the price of stock should reflect available information correctly and quickly, investors can not obtain the abnormal return based on the past stock return. However, in the recent years, many practitioners and academics found there are some anomaly phenomenon existed in the stock market which caused strong debate with EMH (Efficient Market Hypothesis), such as continuation return and reversal return. Then, continuation return and reversal return can cause the momentum and contrarian investing strategies, respectively. If the momentum and contrarian trading strategies can generate abnormal return, it means the market is efficient. On the other hand, whether momentum and contrarian trading strategies can effect in some country's stock market, which is very important for individual and institutional investors. After China joined into WTO, which has played an important role in global stock market. Therefore, in this paper, following the method examined by Jegadeesh and Titman (2001), we studied the effects of momentum and contrarian trading strategies in the China's stock market over 17 - year from 1994 to 2010.

Option prices tend to be correlated to past stock market returns due to market imperfections. This chapter discuss this issue in Chinese derivative market. Implied volatility spread based on pairs of options is constructed to measure the price pressure in the option market. By regressing the implied volatility spread on past stock returns, we find that past stock returns exert a strong influence on the pricing of index options. Specifically, the SSE 50 ETF calls are significantly overvalued relative to SSE 50 ETF puts after stock price increases, and vice versa. Moreover, we empirically validate that momentum effects in the underlying stock market are responsible for the price pressure. These findings are both economically and statistically significant and have important implications.

Option prices tend to be correlated to past stock market returns due to market imperfections. We unprecedentedly examine this issue on the SSE 50 ETF option in the Chinese derivatives market. To measure the price pressure in the options market, we construct an implied volatility spread based on pairs of the SSE 50 ETF option with identical expiration dates and strike prices. By regressing the implied volatility spread on past stock returns, we find that past stock returns exert a strong influence on the pricing of index options. Specifically, we find that SSE 50 ETF calls are significantly overvalued relative to SSE 50 ETF puts after stock price increases and the reverse is also true after the stock price decreases. Moreover, we validate the momentum effects in the underlying stock market to be responsible for the price pressure. These findings are both economically and statistically significant and have important implications.

Despite its importance for the analysis of life-cycle behavior and, in particular, retirement planning, stock ownership by private households is poorly understood. Among other approaches to investigate this puzzle, recent research has started to elicit private households' expectations of stock market returns. This paper reports findings from a study that collected data over a two-year period both on households' stock market expectations (subjective probabilities of gains or losses) and on whether they own stocks. We document substantial heterogeneity in financial market expectations. Expectations are correlated with stock ownership. Over the two years of our data, stock market prices increased, and expectations of future stock market price changes also increased, lending support to the view that expectations are influenced by recent stock gains or losses.

Stock Market Expectations of Dutch Households

Survey evidence suggests that many investors form beliefs about future stock market returns by extrapolating past returns: they expect the stock market to perform well (poorly) in the near future if it performed well (poorly) in the recent past. Such beliefs are hard to reconcile with existing models of the aggregate stock market. We study a consumption-based asset pricing model in which some investors form beliefs about future price changes in the stock market by extrapolating past price changes, while other investors hold fully rational beliefs. We find that the model captures many features of actual prices and returns, but is also consistent with the survey evidence on investor expectations. This suggests that the survey evidence does not need to be seen as an inconvenient obstacle to understanding the stock market; on the contrary, it is consistent with the facts about prices and returns, and may be the key to understanding them.

Properties of Implied Cost of Capital Using Analysts' Forecasts

Introducing more speculators into the market for a given commodity leads to improved risk sharing but can also change the informational content of prices. This inflicts an externality on those traders already in the market, whose ability to make inferences based on current prices will be aff ected. In some cases, the externality is negative: the entry of new s peculators lowers the informativeness of the price to existing trader s. The net result can be one of price destabilization and welfare red uction. This is true even when all agents are rational, risk-averse c ompetitors who make the best possible use of their available informat ion. Copyright 1987 by University of Chicago Press.